<PAGE> 1
SCHEDULE 14A
(RULE 14a-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. )
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
<TABLE>
<S> <C>
[ ] Preliminary Proxy Statement [ ] CONFIDENTIAL, FOR USE OF THE
COMMISSION ONLY (AS PERMITTED BY
RULE 14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
</TABLE>
TESORO PETROLEUM CORPORATION
- --------------------------------------------------------------------------------
(Name of Registrant as Specified in its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1) Title of each class of securities to which transaction applies:
-----------------------------------------------------------------------
(2) Aggregate number of securities to which transaction applies:
-----------------------------------------------------------------------
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):
-----------------------------------------------------------------------
(4) Proposed maximum aggregate value of transaction:
-----------------------------------------------------------------------
(5) Total fee paid:
-----------------------------------------------------------------------
[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
-----------------------------------------------------------------------
(2) Form, Schedule or Registration Statement No.:
-----------------------------------------------------------------------
(3) Filing Party:
-----------------------------------------------------------------------
(4) Date Filed:
-----------------------------------------------------------------------
<PAGE> 2
TESORO PETROLEUM CORPORATION
---------------------
NOTICE OF 1999 ANNUAL MEETING OF STOCKHOLDERS
SEPTEMBER 15, 1999
---------------------
The 1999 Annual Meeting of Stockholders of Tesoro Petroleum Corporation
(the "Company") will be held at the Hotel Crescent Court, 400 Crescent Court,
Dallas, Texas, at 10:00 A.M. Central time on Wednesday, September 15, 1999, for
the following purposes:
1. To elect seven directors of the Company;
2. To ratify the appointment of Deloitte & Touche LLP as the Company's
independent auditors for fiscal year 1999; and
3. To transact such other business as may properly come before the
meeting or any adjournment thereof.
Holders of Common Stock of record at the close of business on August 3,
1999, are entitled to notice of and to vote at the annual meeting.
By Order of the Board of Directors,
JAMES C. REED, JR.
Secretary
August 16, 1999
San Antonio, Texas
---------------------
YOUR VOTE IS IMPORTANT. IF YOU DO NOT EXPECT TO ATTEND THE ANNUAL MEETING, OR IF
YOU DO PLAN TO ATTEND BUT WISH TO VOTE BY PROXY, PLEASE DATE, SIGN AND MAIL
PROMPTLY THE ENCLOSED PROXY. A RETURN ENVELOPE IS PROVIDED FOR THIS PURPOSE.
<PAGE> 3
TESORO PETROLEUM CORPORATION
PROXY STATEMENT
---------------------
1999 ANNUAL MEETING OF STOCKHOLDERS
SEPTEMBER 15, 1999
---------------------
GENERAL INFORMATION
This Proxy Statement is furnished in connection with the solicitation by
the Board of Directors (sometimes referred to herein as the "Board") of Tesoro
Petroleum Corporation ("Tesoro" or the "Company") of proxies to be voted at the
1999 Annual Meeting of Stockholders to be held on Wednesday, September 15, 1999,
and at any adjournment thereof.
Each proxy will be voted as specified thereon by the stockholder. Any duly
executed proxy not specifying the contrary will be voted (i) for the directors
nominated for election at the meeting and (ii) for the ratification of the
appointment of Deloitte & Touche LLP as the Company's independent auditors for
fiscal year 1999. A stockholder giving a proxy may revoke it by written notice
to the Secretary of the Company at any time before it is voted.
At the close of business on August 3, 1999, the record date for the 1999
annual meeting, there were outstanding and entitled to vote 32,349,542 shares of
Common Stock of the Company. The holders of Common Stock are entitled to one
vote for each share held by them on all matters submitted to them. The Company
has no other voting securities outstanding.
A copy of the Company's Summary Annual Report for fiscal year 1998 has
previously been mailed to all stockholders as of the record date. The Company's
complete Consolidated Financial Statements, Selected Financial Data,
Management's Discussion and Analysis of Financial Condition and Results of
Operations and Quantitative and Qualitative Disclosures About Market Risk, taken
from the Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1998, are included in Appendix A to this document. Such Summary Annual
Report and Appendix A hereto do not constitute a part of the proxy materials.
The principal executive offices of the Company are located at 8700 Tesoro
Drive, San Antonio, Texas 78217-6218. This Proxy Statement and accompanying form
of proxy are being mailed to stockholders on or about August 16, 1999.
<PAGE> 4
1. ELECTION OF DIRECTORS
At the 1999 annual meeting, the stockholders are requested to elect seven
directors, constituting the whole Board of Directors, to hold office until the
2000 Annual Meeting of Stockholders or until their successors are elected and
qualified. Proxies cannot be voted for more than seven nominees. As set forth
below, Mr. Donald H. Schmude has been nominated for election as director to fill
a vacancy created by the resignation of Dr. Alan J. Kaufman from the Board
effective August 1, 1999.
Unless otherwise specified, all duly executed proxies received on a timely
basis will be voted for the nominees set forth below. Each of such nominees has
indicated his willingness to serve as a director, if elected, and the Company
has no reason to believe that any nominee will be unable to serve. The persons
designated as proxies, however, reserve full discretion to cast votes for other
persons in the event that any one or more of the nominees are unable to serve.
The election of director nominees requires a plurality of the votes cast at
the election. Under Delaware law and the Company's Restated Certificate of
Incorporation and By-laws, shares as to which a stockholder withholds authority
to vote on the election of directors ("Abstentions"), and shares as to which a
broker indicates that it does not have discretionary authority to vote ("Broker
Non-Votes") on the election of directors, will not be counted as voting thereon
and will not affect the election of the nominees receiving a plurality of the
votes cast.
INFORMATION CONCERNING DIRECTORS AND NOMINEES
Certain information as to each nominee for director is set forth in the
table below and in the following paragraphs. Certain of the information
appearing in the table and notes thereto has been furnished to the Company by
the respective nominees.
<TABLE>
<CAPTION>
SERVED AS
AGE AT DIRECTOR OF
AUGUST 3, THE COMPANY OTHER POSITIONS AND OFFICES
NAME 1999 SINCE WITH THE COMPANY
---- --------- ----------- ----------------------------------
<S> <C> <C> <C>
Steven H. Grapstein............... 41 1992 Vice Chairman of the Board of
Directors(a)(b)(c)(d)
William J. Johnson................ 65 1996 (b)(d)
Raymond K. Mason, Sr. ............ 72 1983 (a)(d)
Donald H. Schmude................. 64 -- --
Bruce A. Smith.................... 55 1995 Chairman of the Board of
Directors, President and Chief
Executive Officer(a)
Patrick J. Ward................... 68 1996 (c)(d)
Murray L. Weidenbaum.............. 72 1992 (a)(c)
</TABLE>
- ---------------
(a) Member of the Executive Committee (Mr. Smith, Chairman).
(b) Member of the Audit Committee (Mr. Grapstein, Chairman).
(c) Member of the Governance Committee (Dr. Weidenbaum, Chairman).
(d) Member of the Compensation Committee (Mr. Mason, Chairman).
---------------------
2
<PAGE> 5
Steven H. Grapstein has been Chief Executive Officer of Kuo Investment
Company and subsidiaries ("Kuo"), an international investment group, since
January 1997. From September 1985 to January 1997, Mr. Grapstein was a Vice
President of Kuo. He is also a director of several of the Kuo companies. Mr.
Grapstein has been a Vice President of Oakville N.V. ("Oakville"), a Kuo
subsidiary, since 1989.
William J. Johnson has been a petroleum consultant and president of JonLoc
Inc., a private company engaged in oil and gas investments, since 1994. From
1990 through 1994, Mr. Johnson served as President, Chief Operating Officer and
a director of Apache Corporation, a large independent oil and gas company. Mr.
Johnson is on the Board of Directors of J. Ray McDermott, S.A., an engineering
and construction company.
Raymond K. Mason, Sr., served as Chairman of the Board of Directors of
American Banks of Florida, Inc., from 1978 to 1998.
Donald H. Schmude has 36 years of experience in the energy industry with
Texaco and Star Enterprise, a Texaco and Saudi Aramco joint venture. Prior to
his retirement from Texaco in 1994, he was Vice President of Texaco and
President and Chief Executive Officer of Texaco Refining & Marketing Inc. in
Houston, Texas and Los Angeles, California. He also served as Vice President of
Texaco, Inc., Special Projects, in Anacortes, Washington, and held various
refinery engineering, planning and marketing positions.
Bruce A. Smith has been Chairman of the Board of Directors, President and
Chief Executive Officer of the Company since June 1996. He has been a director
of the Company since July 1995. Mr. Smith was President and Chief Executive
Officer of the Company from September 1995 to June 1996; Executive Vice
President, Chief Financial Officer and Chief Operating Officer of the Company
from July 1995 to September 1995; Executive Vice President responsible for
Exploration and Production and Chief Financial Officer of the Company from
September 1993 to July 1995.
Patrick J. Ward has 47 years of experience in international energy
operations with Caltex Petroleum Corporation, a 50/50 joint venture of Chevron
Corp. and Texaco, Inc., engaged in the business of refining and marketing. Prior
to his retirement in August 1995, he was Chairman, President and Chief Executive
Officer of Caltex, positions he had held since 1990. Mr. Ward served on the
Board of Directors of Caltex from 1989 to 1995.
Murray L. Weidenbaum, an economist and educator, has been the Mallinckrodt
Distinguished University Professor and Chairman of the Center for the Study of
American Business at Washington University in St. Louis, Missouri, since 1975.
No director or nominee for election as director of the Company has a family
relationship with any other director, nominee or executive officer of the
Company.
---------------------
The Board of Directors met nine times during fiscal year 1998. Each member
of the Board of Directors attended at least 75 percent of the meetings of the
Board and committees on which such director served during fiscal year 1998. The
Board of Directors has an Executive Committee and the following standing
committees: Audit Committee, Compensation Committee and Governance Committee.
The Executive Committee, between meetings of the Board and while the Board
is not in session, has and may exercise all the powers and authority of the
Board in the management of the business and affairs of the Company as provided
in Article III of the By-laws of the Company and has and may exercise such other
powers and authority as may be lawfully delegated to such committee by the
Board, including the power and authority (i) to declare a dividend on the
Company's capital stock, (ii) to authorize the issuance of the Company's capital
stock, (iii) to adopt a certificate of ownership and merger pursuant to Section
253 of the Delaware General Corporation Law, and (iv) to the extent authorized
in any resolution or resolutions providing for the issuance of shares of stock
adopted by the Board or the Executive Committee as provided in subsection (a) of
Section 151 of the Delaware General Corporation Law, to fix the designations and
any of the preferences or rights of such shares relating to dividends,
redemption, dissolution, any distribution of assets of the Company or the
conversion into, or the exchange of such shares for, shares of any other class
or classes or
3
<PAGE> 6
any other series of the same or any other class or classes of stock of the
Company or fix the number of shares of any series of stock or authorize the
increase or decrease of the shares of any series. The Executive Committee met
one time during fiscal year 1998.
The Audit Committee's primary purposes are (i) to aid the individual
directors and the Board of Directors as a whole in performing and fulfilling
their oversight responsibilities for financial reporting to the public; (ii) to
aid in maintaining the corporate image and credibility as it relates to
financial reporting; (iii) to recommend and support, with management and/or the
Board of Directors, as appropriate, efforts to improve and maintain standards
and procedures for financial control and quality financial reporting; (iv) to
provide communication, as necessary, between the Board of Directors and control
and accounting, legal, internal auditing and the external auditors; and (v) to
recommend and support, with management and/or the Board of Directors, as
appropriate, efforts to assure the Company's compliance with the requirements of
the Foreign Corrupt Practices Act of 1977, as amended. The Audit Committee met
three times during fiscal year 1998.
The Compensation Committee's primary purposes are (i) to review and approve
all areas of senior executive compensation including but not limited to salary
adjustments, cash incentive awards and stock incentives, and to review and
approve the aggregate amount of all merit increases, cash incentive awards and
stock incentives for the Company's other executives; (ii) to administer and
interpret the Company's Amended Incentive Stock Plan of 1982, Amended and
Restated Executive Long-Term Incentive Plan (the "1993 Plan") and any future
incentive plans, to the extent set forth in such plans; (iii) to review Company
retirement matters, consider amendments to the Company's retirement plans based
on cost and benefit considerations, make recommendations to the Board of
Directors in respect to such amendments and proposals, and review and approve
any overall changes in retirement benefit formulas; (iv) to review new
employment agreements, amendments and extensions of existing employment
agreements, and to make recommendations to the Board of Directors with respect
to such agreements; (v) to administer and interpret employment agreements and
make recommendations to the Board of Directors with respect thereto; and (vi) to
consult with the Board of Directors and review with the Board the actions of the
Compensation Committee as appropriate. The Compensation Committee met eight
times during fiscal year 1998.
The Governance Committee considers and recommends to the Board from time to
time suitable candidates for membership on the Board, including nominees
recommended by stockholders. Stockholders wishing to submit a recommendation
should write to the Governance Committee. Stockholders may also make nominations
for director at annual or certain special stockholder meetings if they comply
with the procedures described below. The Governance Committee also reviews and
makes recommendations to the Board annually regarding (i) the organization and
structure of the Board and the committees of the Board and selection of new
director candidates; (ii) compensation for the members of the Board; (iii)
guidelines on corporate governance issues; and (iv) the role and effectiveness
of the Chief Executive Officer, the Board and each committee of the Board. The
Governance Committee met three times during fiscal year 1998.
Under the Company's By-laws, a stockholder of the Company entitled to vote
for the election of directors, may, if he or she complies with the following
procedures, make a nomination for director at a stockholder meeting. Nominations
for director may be made by stockholders only after compliance with the
procedures set forth in the Company's By-laws. The following summary is
qualified in its entirety by reference to the full text of the By-laws. Written
notice of such stockholder's intent to make such nomination must be delivered to
the Company (Attention: Corporate Secretary) on a timely basis as set forth
below and must contain (i) the name and address of the stockholder as it appears
on the Company's books and of the beneficial owner, if any, on behalf of whom
such nomination is made, and (ii) as to each person whom the stockholder
proposes to nominate for election as a director, all information relating to
such person that is required to be disclosed in solicitation of proxies for
election of directors, or is otherwise required, by Regulation 14A under the
Securities Exchange Act of 1934, as amended ("Exchange Act") (including such
person's written consent to being named in the proxy statement as a nominee and
to serving as a director if elected).
In the case of an annual meeting of stockholders, the required notice must
be delivered not less than 60 days nor more than 90 days prior to the first
anniversary of the preceding year's annual meeting; provided that, in the event
that the date of the annual meeting is advanced by more than 30 days or delayed
by more
4
<PAGE> 7
than 60 days from such anniversary date, the notice must be delivered no earlier
than the ninetieth day prior to such annual meeting and not later than the close
of business on the later of the sixtieth day prior to such annual meeting or the
tenth day following the day on which public announcement of the date of such
meeting is first made. If the number of directors to be elected to the Board is
increased and there is no public announcement specifying the size of the
increased Board made by the Company at least 70 days prior to the first
anniversary of the preceding year's annual meeting, a notice will be considered
timely, but only with respect to nominees for any new positions created by such
increase, if delivered not later than the close of business on the tenth day
following the day on which the public announcement is first made by the Company.
In the case of a special meeting of stockholders at which directors are proposed
to be elected in the notice of meeting, the stockholder wishing to make a
nomination for director must deliver the required written notice to the Company
(Attention: Corporate Secretary) not earlier than the ninetieth day prior to the
special meeting and not later than the close of business on the later of the
sixtieth day prior to such meeting or the tenth day following the day on which
public announcement is first made of the date of the special meeting and of the
nominees proposed by the Board to be elected at such meeting.
---------------------
COMPENSATION OF DIRECTORS
Each member of the Board of Directors who is not an officer of the Company
receives a base retainer of $18,000 per year, and an additional $2,000 for each
meeting of the Board of Directors or any committee thereof attended in person,
and $1,000 for each telephone meeting, including committee meetings held on the
same day as a meeting of the Board of Directors. The non-executive Vice Chairman
of the Board of Directors receives $25,000 per year for his service. In
addition, the Chairman of the Audit Committee, Chairman of the Compensation
Committee and Chairman of the Governance Committee each receive $5,000 per year
for their service in such positions. The Company provides group life insurance
benefits in the amount of $100,000 and accidental death and dismemberment
insurance up to a maximum of $350,000 for each of the members of the Board of
Directors who are not employees of the Company. The premium for such insurance
ranged from $265 to $5,844 for each of these directors during fiscal year 1998.
Commencing with the 1997 Annual Meeting of Stockholders, one-half of each of the
director's annual retainer is paid in Common Stock of the Company on an annual
basis. The Company issues to each director within 30 days after the annual
meeting of stockholders of the Company at which the director is elected a number
of shares equal to one-half of the annual retainer in effect on the date of such
meeting divided by the average of the closing prices for the Common Stock, as
reported on the New York Stock Exchange ("NYSE") composite tape, for the ten
trading days prior to such annual meeting. The shares of Common Stock issued to
the directors will be held by the Company and will not be sold, pledged or
otherwise disposed of and will not be delivered to the directors until the
earlier of (i) the first anniversary date of the annual meeting which
immediately preceded the issuance of such shares or (ii) the date on which the
person ceases to be a director. The directors will have full voting rights with
respect to such shares of Common Stock.
The Company had established an unfunded Non-Employee Director Retirement
Plan ("Director Retirement Plan") in December 1994 which provided that any
eligible non-employee director who elected to participate in the Director
Retirement Plan and who had served on the Company's Board of Directors for at
least three full years would be entitled to a retirement payment in cash
beginning the later of the director's sixty-fifth birthday or such later date
that the individual's service as a director ended. However, to more closely
align director compensation with shareholders' interest, in March 1997, the
Board of Directors amended the Director Retirement Plan to freeze the plan and
convert the accrued benefits of each current director under the plan to a
lump-sum present value which was transferred to an account ("Account") for each
director in the Tesoro Petroleum Corporation Board of Directors Deferred Phantom
Stock Plan ("Phantom Stock Plan"). After the amendment and transfer, only those
retired directors or beneficiaries who had begun receiving benefits remained
participants in the Director Retirement Plan. By participating in the Phantom
Stock Plan, each director waives any and all rights under the Director
Retirement Plan. Commencing with 1997, each current and future non-employee
director ("Participant") shall have credited to his Account as of the last day
of the year a yearly accrual equal to $7,250, prorated to $6,042 for 1997
(limited to 15 accruals, including previous accruals of retirement benefits
under the Director Retirement Plan); and each Participant who is serving as a
chairman of a committee of the Board of Directors immediately prior to
5
<PAGE> 8
his termination as director and who has served at least three years as a
director shall have an additional $5,000 credited to his Account. The Phantom
Stock Plan allows for pro rata calculations of the yearly accrual in the event a
director serves for part of a year. In addition, a Participant may elect to
defer any part or all of the cash portion of his annual director retainer into
his Account. Each transfer, accrual or deferral shall be credited quarterly to
the Participant's Account in units based upon the number of shares that could
have been purchased with the dollars credited based upon the closing price of
the Company's Common Stock on the NYSE on the date the amount is credited.
Dividends or other distributions accrue to the Participant's Account.
Participants are vested 100 percent at all times with respect to deferrals and,
if applicable, the chairman fee portion of his Account. Participants vest in
amounts transferred from the Director Retirement Plan and the yearly accruals
upon completion of three full years of service (including all service prior to
March 6, 1997) as a member of the Board. If a Participant voluntarily resigns or
is removed from the Board prior to serving three years on the Board, he shall
forfeit all amounts not vested. If a director dies, retires, or becomes
disabled, he shall be 100 percent vested in his Account without regard to
services. Distributions from the Phantom Stock Plan shall be made in cash, based
on the closing market price of the Company's Common Stock on the NYSE on the
business day immediately preceding the date on which the cash distribution is to
be made, and such distributions shall be made in either a lump-sum distribution
or in annual installments not exceeding ten years. Death, disability, retirement
or cessation of a Participant as a director of the Company constitute an event
requiring a distribution. Upon the death of a Participant, the Participant's
beneficiary will receive as soon as practicable the cash value of the
Participant's Account as of the date of death. At December 31, 1998, each
Participant's Account was comprised of 4,474 units, 1,767 units, 14,736 units,
2,209 units and 7,433 units of phantom stock for Messrs. Grapstein, Johnson,
Mason, Ward and Weidenbaum, respectively.
Under the Tesoro Petroleum Corporation Board of Directors Deferred
Compensation Plan ("Deferred Compensation Plan"), a director electing to
participate may defer between 20 percent and 100 percent of his total cash
compensation for the ensuing year, which deferred fees are credited to an
interest-bearing account maintained by the Company. Interest is applied to each
quarter's deferral at the prime rate published in The Wall Street Journal on the
last business day of such quarter plus two percentage points (9.75 percent at
December 31, 1998). All payments under the Deferred Compensation Plan are the
sole obligation of the Company. Upon the death of a participating director, the
balance in his account under the Deferred Compensation Plan is paid to his
beneficiary or beneficiaries in one lump sum. In the event of the disability,
retirement or the removal or resignation prior to the death, disability or
retirement of a participating director, the balance in his account will be paid
to such director in ten equal annual installments. In the event of a change of
control (as "change of control" is defined in the Deferred Compensation Plan),
the balance in each participating director's account will be distributed to him
as a lump sum within 30 days after the date of the change of control. The
Company also has an agreement with Frost National Bank of San Antonio, Texas,
under which the Tesoro Petroleum Corporation Board of Directors Deferred
Compensation Trust was established for the sole purpose of creating a fund to
provide for the payment of deferred compensation to participating directors
under the Deferred Compensation Plan.
The Company's 1995 Non-Employee Director Stock Option Plan ("1995 Plan")
provides for the grant to non-employee directors of automatic, non-discretionary
stock options, at an exercise price equal to the fair market value of the Common
Stock as of the date of grant. Under the 1995 Plan, each person serving as a
non-employee director on February 23, 1995, or elected thereafter, initially
receives an option to purchase 5,000 shares of the Company's Common Stock.
Thereafter, each non-employee director, while the 1995 Plan is in effect and
shares are available to grant, will be granted an option to purchase 1,000
shares of Common Stock on the next day after each annual meeting of the
Company's stockholders but not later than June 1, if no annual meeting is held.
All options under the 1995 Plan become exercisable six months after the date of
grant. The 1995 Plan will terminate as to the issuance of stock options in
February 2005. Under the 1995 Plan, stock options for 1,000 shares with an
exercise price of $16.1875 per share were granted to each non-employee director
of the Company on July 30, 1998. At August 3, 1999, the Company had 56,000
options outstanding and 71,000 shares available for future grants under the 1995
Plan.
---------------------
6
<PAGE> 9
STOCK OWNERSHIP
The following table shows the beneficial ownership of the Company's Common
Stock reported to the Company as of August 3, 1999, including shares as to which
a right to acquire ownership exists (for example, through the exercise of stock
options or stock awards or conversion of Premium Income Equity Securities
("PIES")) within the meaning of Rule 13d-3(d)(1) under the Exchange Act for each
director and nominee, the Chief Executive Officer, the other four most highly
compensated officers of the Company during 1998 and, as a group, such persons
and other executive officers. Unless otherwise indicated, each person or member
of the group listed has sole voting and investment power with respect to the
shares of Common Stock listed. The PIES, which represent fractional interests in
the Company's 7.25% Mandatorily Convertible Preferred Stock, have no voting
rights. Before July 1, 2001, each PIES is convertible, at the option of the
holder thereof, into 0.8455 shares of Common Stock.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP OF
COMMON STOCK ON
AUGUST 3, 1999
-------------------------
PERCENT
SHARES OF CLASS
--------- --------
<S> <C> <C>
Steven H. Grapstein......................................... 947,942(a)(b) 2.921
William J. Johnson.......................................... 8,328(a) 0.026
Raymond K. Mason, Sr. ...................................... 27,756(a) 0.086
Donald H. Schmude........................................... -- --
Bruce A. Smith.............................................. 463,431(c) 1.418
Patrick J. Ward............................................. 15,328(a)(d) 0.047
Murray L. Weidenbaum........................................ 11,328(a) 0.035
William T. Van Kleef........................................ 179,045(e) 0.551
James C. Reed, Jr. ......................................... 153,069(f) 0.472
Stephen L. Wormington....................................... 154,968(g) 0.477
Robert W. Oliver............................................ 119,743(h) 0.369
All directors, nominees for election as a director and
executive officers as a group (17 individuals)............ 2,364,193(i) 7.046
</TABLE>
- ---------------
(a) The shares shown include 9,000; 7,000; 9,000; 8,000; and 9,000 shares for
Mr. Grapstein, Mr. Johnson, Mr. Mason, Mr. Ward, and Dr. Weidenbaum,
respectively, which such directors had the right to acquire through the
exercise of stock options on August 3, 1999, or within 60 days thereafter.
Units of phantom stock payable in cash which have been credited to the
directors under the Phantom Stock Plan (see page 5) and to Mr. Smith, Mr.
Van Kleef and Mr. Reed under the 1998 Performance Incentive Compensation
Plan ("1998 Performance Plan") (see page 14) are not included in the shares
shown above.
(b) The shares shown include 846,300 shares of the Company's Common Stock owned
by Oakville. Mr. Grapstein is an officer of Oakville. As an officer, Mr.
Grapstein shares voting and investment power with respect to such shares.
The shares shown also include 84,550 shares which could be obtained upon
the conversion of 100,000 PIES owned by Oakville into Common Stock on
August 3, 1999. In addition, the shares shown include 6,764 shares which
could be obtained upon the conversion of 8,000 PIES into Common Stock on
August 3, 1999, for which Mr. Grapstein disclaims beneficial ownership of
4,000 PIES held in accounts for his minor children.
(c) The shares shown include 3,549 shares credited to Mr. Smith's account under
the Company's Thrift Plan and 330,134 shares which Mr. Smith had the right
to acquire through the exercise of stock options on August 3, 1999, or
within 60 days thereafter.
(d) The shares shown include 6,000 shares owned by the P&L Family Partnership
Ltd. which Mr. Ward and his spouse control through 90 percent ownership.
(e) The shares shown include 2,869 shares credited to Mr. Van Kleef's account
under the Company's Thrift Plan and 124,706 shares which Mr. Van Kleef had
the right to acquire through the exercise of stock options or stock awards
on August 3, 1999, or within 60 days thereafter.
7
<PAGE> 10
(f) The shares shown include 1,632 shares credited to Mr. Reed's account under
the Company's Thrift Plan and 92,384 shares which Mr. Reed had the right to
acquire through the exercise of stock options on August 3, 1999, or within
60 days thereafter.
(g) The shares shown include 2,052 shares credited to Mr. Wormington's account
under the Company's Thrift Plan and 152,916 shares which Mr. Wormington had
the right to acquire through the exercise of stock options on August 3,
1999, or within 60 days thereafter.
(h) The shares shown include 827 shares credited to Mr. Oliver's account under
the Company's Thrift Plan and 117,916 shares which Mr. Oliver had the right
to acquire through the exercise of stock options on August 3, 1999, or
within 60 days thereafter. The shares shown also include 1,000 shares held
in the name of Mr. Oliver's spouse for which he disclaims beneficial
ownership.
(i) The shares shown include 16,814 shares credited to the accounts of
executive officers and directors under the Company's Thrift Plan and
1,108,123 shares which directors and executive officers had the right to
acquire through the exercise of stock options or stock awards on August 3,
1999, or within 60 days thereafter. The shares shown also include 3,382
shares which an executive officer could obtain upon the conversion of 4,000
PIES into Common Stock on August 3, 1999. The shares shown also include
2,334 shares held in the name of executive officers' spouses for which each
executive officer disclaims beneficial ownership and 3,000 shares acquired
in the name of an executive officer's mother with respect to which such
executive officer has voting and investment power.
---------------------
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth information based on filings made with the
Securities and Exchange Commission ("SEC") as to each person or group who on
August 3, 1999, beneficially owned more than 5 percent of the outstanding shares
of Common Stock of the Company.
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP
--------------------
NUMBER PERCENT
TITLE OF CLASS NAME AND ADDRESS OF BENEFICIAL OWNER OF SHARES OF CLASS
-------------- ------------------------------------ --------- --------
<S> <C> <C> <C>
Common Stock...................... Wanger Asset Management, L.P.(a) 3,692,700 11.415
227 West Monroe Street, Suite 3000
Chicago, IL 60606
Common Stock...................... Dimensional Fund Advisors Inc.(b) 1,857,700 5.743
1299 Ocean Avenue, 11th Floor
Santa Monica, CA 90401
Common Stock(c)................... Salomon Brothers Asset Management, Inc. 2,433,235 6.996
388 Greenwich Street
New York, NY 10013
Salomon Brothers Holding Company, Inc. 2,470,763 7.096
388 Greenwich Street
New York, NY 10013
Salomon Smith Barney Holdings, Inc. 3,773,876 10.447
388 Greenwich Street
New York, NY 10013
Citigroup, Inc. 3,793,676 10.496
153 East 53rd Street
New York, NY 10043
</TABLE>
- ---------------
(a) According to Amendment No. 3 to a Schedule 13G ("Amendment No. 3") filed
with the SEC, Wanger Asset Management, L.P. ("WAM") states that it is a
Delaware limited partnership and an Investment Adviser registered under
Section 203 of the Investment Advisers Act of 1940 and Wanger Asset
Management Ltd. states that it is a Delaware corporation and the General
Partner of the Investment Adviser. Amendment No. 3 indicates that the
shares reported therein have been acquired on behalf of discretionary
clients of WAM and that persons other than WAM are entitled to receive all
dividends
8
<PAGE> 11
from, and proceeds from the sale of, those shares. According to Amendment
No. 3, within the meaning of Rule 13d-3 of the Exchange Act, WAM
beneficially owns the shares shown in the table above and possesses shared
power to vote or to direct the vote and shared power to dispose or direct
the disposition of these shares.
(b) According to a Schedule 13G filed with the SEC, Dimensional Fund Advisors
Inc. ("Dimensional") states that it is a Delaware corporation and an
investment adviser registered under the Investment Advisers Act of 1940. In
the Schedule 13G, Dimensional states that it furnishes investment advice to
four investment companies registered under the Investment Company Act of
1940 and serves as investment manager to certain other investment vehicles,
including commingled group trusts. These investment companies and
investment vehicles are the "Portfolios." In the Schedule 13G, Dimensional
states that in its role as investment adviser and investment manager,
Dimensional possesses both voting and investment power over the 1,857,700
shares of Common Stock that are owned by the Portfolios. Dimensional states
that the 1,857,700 shares of Common Stock are owned by the Portfolios and
disclaims beneficial ownership of such securities.
(c) According to Amendment No. 1 to a Schedule 13G ("Amendment No. 1") filed
jointly with the SEC, Salomon Brothers Asset Management Inc. ("SBAM"),
Salomon Brothers Holding Company Inc. ("SBHC"), Salomon Smith Barney
Holdings Inc. ("SSB Holdings") and Citigroup Inc. ("Citigroup")
(collectively, the "Reporting Persons") state that they are Delaware
corporations and are either an investment adviser registered under the
Investment Company Act of 1940 or a parent holding company or control
person within the meaning of Section 13(d) of the Exchange Act. According
to Amendment No. 1, SBHC is the sole stockholder of SBAM; SSB Holdings is
the sole stockholder of SBHC; and Citigroup is the sole stockholder of SSB
Holdings. In Amendment No. 1, each Reporting Person shows that they have
shared voting and dispositive power and may be deemed to beneficially own
the shares shown in the table above (assuming conversion of certain
securities held), except that in an exhibit to Amendment No. 1, SSB
Holdings and Citigroup each disclaim beneficial ownership of these
securities.
---------------------
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's directors,
executive officers and holders of more than 10 percent of the Company's voting
stock to file with the SEC initial reports of ownership and reports of changes
in ownership of Common Stock or other equity securities of the Company. The
Company believes that during the fiscal year ended December 31, 1998, its
directors, executive officers and holders of more than 10 percent of the
Company's voting stock complied with all Section 16(a) filing requirements with
the following exception: Mr. Grapstein failed to timely report an aggregate of
eleven transactions in January 1998 with respect to 131,000 shares of the
Company's Common Stock sold by Oakville, of which Mr. Grapstein is a Vice
President; and a transaction in July 1998 with respect to 4,000 PIES, for which
he disclaims beneficial ownership, acquired for the accounts of Mr. Grapstein's
minor children.
---------------------
9
<PAGE> 12
EXECUTIVE OFFICERS OF THE REGISTRANT
The following is a list of the Company's executive officers, their ages and
their positions with the Company at August 3, 1999.
<TABLE>
<CAPTION>
POSITION
NAME AGE POSITION HELD SINCE
---- --- -------- ----------
<S> <C> <C> <C>
Bruce A. Smith.......... 55 Chairman of the Board of Directors, President and June 1996
Chief Executive Officer
William T. Van Kleef.... 47 Executive Vice President and Chief Operating July 1998
Officer
James C. Reed, Jr. ..... 54 Executive Vice President, General Counsel and September 1995
Secretary
Thomas E. Reardon....... 53 Senior Vice President, Corporate Resources May 1998
Donald A. Nyberg........ 47 President, Tesoro Marine Services, Inc. November 1996
Robert W. Oliver........ 45 President, Tesoro Exploration and Production September 1995
Company
Stephen L. Wormington... 54 Executive Vice President and Chief Operating May 1998
Officer, Tesoro Refining, Marketing & Supply
Company
Don E. Beere............ 58 Vice President, Information Technology Projects May 1998
Bobby J. Culpepper...... 49 Vice President, Information Technology July 1998
Don M. Heep............. 50 Vice President, Controller May 1998
Gregory A. Wright....... 49 Vice President, Finance and Treasurer May 1998
</TABLE>
There are no family relationships among the officers listed, and there are
no arrangements or understandings pursuant to which any of them were elected as
officers. Officers are elected annually by the Board of Directors at its first
meeting following the Annual Meeting of Stockholders, each to hold office until
the corresponding meeting of the Board in the next year or until a successor
shall have been elected or shall have qualified. The Company's executive
officers have been employed by the Company or its subsidiaries in an executive
capacity for at least the past five years, except for those named below who have
had the business experience indicated during that period. Positions, unless
otherwise specified, are with the Company.
Thomas E. Reardon.......... Senior Vice President, Corporate Resources since
May 1998. Vice President, Human Resources and
Environmental, from September 1995 to May 1998.
Vice President, Human Resources and Environmental
Services, of Tesoro Petroleum Companies, Inc., a
subsidiary of the Company, from October 1994 to
September 1995. Vice President, Human Resources, of
Tesoro Petroleum Companies, Inc. from February 1990
to October 1994.
Donald A. Nyberg........... President of Tesoro Marine Services, Inc., a
subsidiary of the Company, since November 1996.
Vice President, Strategic Planning, of MAPCO Inc.
from January 1996 to November 1996. President and
Chief Executive Officer of Marya Resources from
August 1994 to January 1996. President and Chief
Executive Officer of BP Pipelines Inc. and Vice
President, BP Exploration, of The British Petroleum
Group, Ltd., from 1991 to 1994.
Robert W. Oliver........... President of Tesoro Exploration and Production
Company, a subsidiary of the Company, since
September 1995. Independent consultant from
November 1994 to September 1995. Vice President,
Exploration/Acquisitions, of Bridge Oil (USA) Inc.
from December 1988 to November 1994.
Stephen L. Wormington...... Executive Vice President and Chief Operating
Officer of Tesoro Refining, Marketing & Supply
Company, a subsidiary of the Company, since May
1998. President of Tesoro Alaska Petroleum Company,
a subsidiary of the Company, from September 1995 to
August 1998. Vice President, Supply and Operations
Coordination, of Tesoro Alaska Petroleum
10
<PAGE> 13
Company from April 1995 to September 1995. General
Manager, Strategic Projects, from January 1995 to
April 1995. Executive Vice President, Special
Projects, of MG Refining & Marketing, Inc. from
January 1994 to January 1995. Executive Vice
President of MG Natural Gas Corp. from May 1992 to
January 1994.
Bobby J. Culpepper......... Vice President, Information Technology since July
1998. Vice President, Information Technology, of
Tesoro Petroleum Companies, Inc., a subsidiary of
the Company, since June 1998. Vice President,
Operations of Microage Integration Group from July
1997 to May 1998. Vice President, Information
Technology, of Phillips 66 Company, a division of
Phillips Petroleum Company from May 1991 to June
1997.
Don M. Heep................ Vice President, Controller since May 1998. Senior
Vice President, Administration for Tesoro Alaska
Petroleum Company, a subsidiary of the Company,
from November 1996 to May 1998. Senior Vice
President and Chief Financial Officer of Valero
Energy Corporation from 1994 to 1996. Vice
President and Chief Accounting Officer of Valero
Energy Corporation from 1992 to 1994.
Gregory A. Wright.......... Vice President, Finance and Treasurer since May
1998. Vice President and Treasurer from September
1995 to May 1998. Vice President, Corporate
Communications from February 1995 to September
1995. Vice President, Corporate Communications, of
Tesoro Petroleum Companies, Inc., a subsidiary of
the Company, from January 1995 to February 1995.
Vice President, Business Development of Valero
Energy Corporation from 1994 to January 1995. Vice
President, Corporate Planning of Valero Energy
Corporation from 1992 to 1994.
---------------------
11
<PAGE> 14
EXECUTIVE COMPENSATION
SUMMARY OF COMPENSATION
The following table contains information concerning the annual and
long-term compensation for services in all capacities to the Company for fiscal
years ended December 31, 1998, 1997 and 1996, of those persons who were on
December 31, 1998, (i) the Chief Executive Officer and (ii) the other four most
highly compensated officers of the Company (collectively, the "named executive
officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
--------------------------------------
AWARDS PAYOUTS
ANNUAL COMPENSATION ------------------------- ----------
---------------------------------- RESTRICTED SECURITIES
OTHER ANNUAL STOCK UNDERLYING LTIP ALL OTHER
SALARY BONUS COMPENSATION AWARD(S) OPTIONS/SARS PAYOUTS COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($)(A) ($) (#)(B) ($) ($)(D)
- --------------------------- ---- -------- -------- ------------ ---------- ------------ ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Bruce A. Smith............... 1998 $616,667 $640,000 $ -- -- 281,900 $4,087,500(c) $1,359,460
Chairman of the Board of 1997 578,269 715,000 -- -- 175,000 -- 1,142,017
Directors, President and 1996 510,096 680,960 -- (c) 170,000 -- 790,751
Chief Executive Officer
William T. Van Kleef......... 1998 $345,833 $325,000 $ -- -- 166,020 $1,532,813(c) $ 466,900
Executive Vice President and 1997 290,231 320,000 -- -- 60,000 -- 369,341
Chief Operating Officer 1996 236,269 248,900 -- (c) 100,000 -- 216,207
James C. Reed, Jr............ 1998 $308,333 $285,000 $ -- -- 48,860 $1,532,813(c) $ 877,859
Executive Vice President, 1997 278,269 295,000 -- -- 45,000 -- 914,363
General Counsel and Secretary 1996 243,673 232,750 -- (c) 50,000 -- 1,004,676
Stephen L. Wormington(e)..... 1998 $290,000 $250,000 $ -- -- 43,780 $ (c) $ 6,400
Executive Vice President and 1997 268,269 280,000 -- -- 45,000 -- 6,400
Chief Operating Officer, 1996 -- -- -- -- (c) -- --
Tesoro Refining, Marketing &
Supply Company
Robert W. Oliver(e).......... 1998 $230,000 $173,000 $ -- -- 31,390 $ (c) $ 6,723
President, Tesoro Exploration 1997 208,269 210,000 -- -- 25,000 -- 6,400
and Production Company 1996 -- -- -- -- (c) -- --
</TABLE>
- ---------------
(a) No payments were made to the named executive officers which are reportable
in Other Annual Compensation. The aggregate amount of perquisites and other
personal benefits was less than either $50,000 or 10 percent of the total
annual salary and bonus reported for the named executive officers for all
periods shown.
(b) Amounts represent traditional stock options granted to each named executive
officer during 1998, 1997 and 1996, except for grants to Mr. Smith in 1997
which were in the form of phantom stock options. At the discretion of the
Compensation Committee of the Board of Directors, the 175,000 phantom stock
options granted to Mr. Smith in 1997 may be converted to traditional stock
options under the 1993 Plan. See table, "Long-Term Incentive
Plans -- Awards in 1998," on page 14 for information related to contingent
awards of phantom stock and cash bonus opportunities under the 1998
Performance Plan.
(c) In 1996, the Compensation Committee of the Board of Directors approved a
special incentive strategy comprised of long-term performance-vested
restricted stock and stock options for the executive officers. Awards of
restricted Common Stock and stock options under this strategy were earned
when the market price of the Company's Common Stock reached an average
price of $20 or higher over any 20 consecutive trading days after June 30,
1997, and before December 31, 1998 ("Performance Target"). In connection
with this strategy, Messrs. Smith, Van Kleef and Reed were awarded 200,000,
75,000 and 75,000 shares, respectively, of restricted Common Stock, and
Messrs. Wormington and Oliver were each granted 75,000 stock options at an
exercise price of $11.375 per share (the fair market value as defined in
the 1993 Plan of a share of the Company's Common Stock on the date of
grant). On May 12, 1998, the Performance Target was achieved which resulted
in the lapse of restrictions on the restricted Common
12
<PAGE> 15
Stock and vesting of the stock options. Long-term incentive plan ("LTIP")
payouts presented above represent the shares of Common Stock awarded under
the incentive compensation strategy times $20.4375 per share, or the
average market price of the Company's Common Stock on the day of reaching
the Performance Target. Although Mr. Wormington and Mr. Oliver became fully
vested in the stock options granted under this strategy upon reaching the
Performance Target, none of the stock options have been exercised.
(d) All Other Compensation for 1998 includes amounts contributed by the Company
and earnings on the respective executive officer's account in the Funded
Executive Security Plan (see "Retirement Benefits" on page 19) of
$1,353,060, $460,500 and $871,459 for Mr. Smith, Mr. Van Kleef and Mr.
Reed, respectively; and amounts contributed to the Company's Thrift Plan of
$6,400 each for Mr. Smith, Mr. Van Kleef, Mr. Reed and Mr. Wormington and
$6,723 for Mr. Oliver. All Other Compensation for 1997 includes amounts
contributed by the Company and earnings on the respective executive
officer's account in the Funded Executive Security Plan of $1,135,617,
$362,941 and $907,963 for Mr. Smith, Mr. Van Kleef and Mr. Reed,
respectively; and amounts contributed to the Company's Thrift Plan of
$6,400 for each of the named executive officers. All Other Compensation for
1996 includes amounts contributed by the Company and earnings on the
respective executive officer's account in the Funded Executive Security
Plan of $786,251, $211,707 and $1,000,176 for Mr. Smith, Mr. Van Kleef and
Mr. Reed, respectively; and amounts contributed to the Company's Thrift
Plan of $4,500 for each of these executive officers.
(e) Since Mr. Wormington and Mr. Oliver were not considered executive officers
during 1996, information is not given for that year.
---------------------
OPTION GRANTS IN 1998
The following table sets forth information concerning individual grants of
traditional stock options pursuant to the 1993 Plan to the named executive
officers during the year ended December 31, 1998. No Stock Appreciation Rights
("SARs") were granted under the 1993 Plan during 1998.
OPTION GRANTS IN 1998
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------- POTENTIAL REALIZABLE VALUE AT
NUMBER OF % OF TOTAL ASSUMED ANNUAL RATES OF
SECURITIES OPTIONS STOCK PRICE APPRECIATION
UNDERLYING GRANTED TO EXERCISE OR FOR OPTION TERM
OPTIONS EMPLOYEES BASE PRICE EXPIRATION -----------------------------
NAME GRANTED (#)(A) IN 1998 ($/SHARE)(B) DATE 5% ($) 10% ($)
- ---- -------------- ---------- ------------ ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Bruce A. Smith........... 281,900 35.5 $15.9375 10/27/08 $2,825,487 $7,160,337
William T. Van Kleef..... 166,020 20.9 15.9375 10/27/08 1,664,021 4,216,954
James C. Reed, Jr. ...... 48,860 6.1 15.9375 10/27/08 489,722 1,241,061
Stephen L. Wormington.... 43,780 5.5 15.9375 10/27/08 438,808 1,112,026
Robert W. Oliver......... 31,390 3.9 15.9375 10/27/08 314,624 797,315
</TABLE>
- ---------------
(a) The right to exercise these options vests in four equal annual installments
beginning one year from the date of grant.
(b) The exercise price per share is equal to the public offering price of a
share of the Company's Common Stock on July 1, 1998, which was above the
market price for the Company's Common Stock on the date of grant of these
options in October 1998.
13
<PAGE> 16
AGGREGATED OPTION/SAR EXERCISES IN 1998 AND OPTION/SAR VALUES AT DECEMBER 31,
1998
The following table reflects the number of unexercised stock options and
SARs remaining at year-end and the potential value thereof based on the year-end
market price of the Company's Common Stock of $12 1/8 per share. No stock
options or SARs were exercised by the named executive officers during 1998.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS/SARS AT IN-THE-MONEY OPTIONS/SARS
SHARES DECEMBER 31, 1998 (#) AT DECEMBER 31, 1998 ($)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ------------ ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Bruce A. Smith.......... -- -- 356,384(a) 541,516(a) $1,216,600 $202,275
William T. Van Kleef.... -- -- 118,706 254,614 188,315 40,204
James C. Reed, Jr. ..... -- -- 92,384 112,476 207,225 46,650
Stephen L. Wormington... -- -- 144,916(b) 110,864 149,250 62,000
Robert W. Oliver........ -- -- 112,916(b) 68,474 114,375 38,750
</TABLE>
- ---------------
(a) The number of unexercised options/SARs include 26,250 exercisable phantom
stock options and 148,750 unexercisable phantom stock options which were
granted to Mr. Smith in 1997.
(b) The number of exercisable options for Mr. Wormington and Mr. Oliver
includes 75,000 stock options each which were earned in May 1998 when the
Performance Target was attained under the special incentive compensation
strategy (see page 12).
LONG-TERM INCENTIVE PLANS -- AWARDS IN 1998
In October 1998, the Company's Board of Directors unanimously approved the
1998 Performance Incentive Compensation Plan (the "1998 Performance Plan"),
which is intended to advance the best interests of the Company and its
stockholders by directly targeting Company performance to align with the
ninetieth percentile historical stock-price growth rate for the Company's peer
group. In addition, the 1998 Performance Plan will provide the Company's
employees with additional compensation, contingent upon achievement of the
targeted objectives, thereby encouraging them to continue in the employ of the
Company. The 1998 Performance Plan has several tiers of awards, with the award
generally determined by job level. The following table and notes thereto provide
information concerning contingent long-term incentive awards granted under the
1998 Performance Plan to the named executive officers during the year ended
December 31, 1998. The long-term incentive awards under the 1998 Performance
Plan are not included in the Summary Compensation Table on page 12.
LONG-TERM INCENTIVE PLANS -- AWARDS IN 1998
<TABLE>
<CAPTION>
ESTIMATED FUTURE PAYOUTS UNDER
PERFORMANCE NON-STOCK
NUMBER OF OR OTHER PRICE-BASED PLANS
SHARES, UNITS PERIOD UNTIL -------------------------------
OR OTHER MATURATION THRESHOLD MAXIMUM
NAME RIGHTS (#) OR PAYOUT(A) ($ OR #) ($ OR #)
---- ------------- ------------ ------------ --------------
<S> <C> <C> <C> <C>
Bruce A. Smith........................ 340,000(b) (a)
William T. Van Kleef.................. 190,000(b) (a)
James C. Reed, Jr. ................... 125,000(b) (a)
Stephen L. Wormington................. -- (a) $377,000(c) $1,508,000(c)
Robert W. Oliver...................... -- (a) $239,200(c) $ 956,800(c)
</TABLE>
- ---------------
(a) Under the 1998 Performance Plan, targeted objectives are comprised of the
fair market value of the Company's Common Stock equaling or exceeding an
average of $35 per share ("First Performance Target") and $45 per share
("Second Performance Target") on any 20 consecutive trading days during a
period commencing on October 1, 1998 and ending on the earlier of September
30, 2002, or the date on which the Second Performance Target is achieved
("Performance Period"). Upon achievement of the
14
<PAGE> 17
First Performance Target, one-fourth of the contingent awards will be
earned, with payout deferred until the end of the Performance Period. The
remaining 75 percent will be earned only upon achievement of the Second
Performance Target.
(b) Shares represent contingent awards of performance-vested phantom stock
granted to Mr. Smith, Mr. Van Kleef and Mr. Reed. If the Second Performance
Target is achieved, the executive officer would be entitled to receive in
cash an amount equal to the number of shares of phantom stock granted to
him multiplied by the fair market value of a share of Common Stock on the
last day of the Performance Period. If the First Performance Target is
attained but the Second Performance is not attained, the executive officer
would receive one-fourth of the amount specified in the preceding sentence.
(c) Mr. Wormington and Mr. Oliver were awarded contingent cash bonus
opportunities under the 1998 Performance Plan. If the Second Performance
Target is achieved, Mr. Wormington and Mr. Oliver would be entitled to
receive a cash bonus equal to five times and four times, respectively, of
their annual "basic compensation," as defined in the 1998 Performance Plan.
If the First Performance Target is attained but the Second Performance is
not attained, Mr. Wormington and Mr. Oliver would receive one-fourth of the
amount specified in the preceding sentence. Based on current salary rates
for Mr. Wormington and Mr. Oliver, estimated future payouts shown above
represent the attainment of the First Performance Target (vesting in
one-fourth of the award) under "Threshold" and the attainment of the Second
Performance Target (earning 100 percent of the award) under "Maximum."
---------------------
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Compensation Committee of the Board of Directors of Tesoro Petroleum
Corporation has prepared the following report regarding 1998 executive
compensation. The Compensation Committee, which is composed entirely of
non-employee directors, is responsible for all components of the Company's
senior executive compensation programs and the aggregate cost-related aspects of
other executive compensation. The Compensation Committee works closely with the
entire Board of Directors in the execution of its duties. This report is
required by rules established by the Securities and Exchange Commission and
provides specific information regarding compensation for the Company's Chairman,
President and Chief Executive Officer and the other officers named in the
Summary Compensation Table, as well as compensation information of all executive
officers of the Company.
COMPENSATION PHILOSOPHY AND OBJECTIVES OF EXECUTIVE COMPENSATION PROGRAMS
It is the philosophy of the Company and the Compensation Committee that all
compensation programs should (i) link pay and performance and (ii) attract,
motivate, reward and retain the executive talent required to achieve corporate
objectives. Tesoro also focuses strongly on compensation tied to stock price
performance, since this form of compensation provides the clearest link to
enhanced shareholder value. From time to time, the Compensation Committee works
with compensation consultants to assist with the design, implementation and
communication of various compensation plans.
The Company determines competitive levels of compensation using published
compensation surveys (for energy and general industry companies of comparable
size to the Company as measured by revenues), information obtained from
compensation consultants and an analysis of compensation data contained in the
proxy statements for the energy industry peer companies included in the
Company's Total Shareholder Return Graph (the "Performance Graph").
The Company's compensation programs for executives include base salaries,
annual performance-based incentives, long-term incentives and certain executive
benefits. Each of these compensation programs is further described below.
15
<PAGE> 18
DESCRIPTION OF THE 1998 EXECUTIVE COMPENSATION PROGRAM
This section of the Compensation Committee's report describes the
compensation programs for executives with specific reference to the objectives
discussed above.
Base Salaries
Base salaries for the Company's senior executive officers in 1998 were
reviewed through comparisons with the market survey data described above. The
Compensation Committee does not consider any financial performance criteria on a
formula basis in determining salary increases. Rather, the Compensation
Committee, using its discretion, considers market base salary rates at the
fiftieth percentile, average annual salary increases for executives in companies
of all sizes across the country, and overall corporate financial performance.
The Compensation Committee also makes a subjective review of individual
performance in making base salary increase decisions for senior executives.
These criteria are assessed in a non-formula fashion and are not weighted. The
current base salary level for each of the named executive officers is, overall,
consistent with the Company's philosophy of targeting the fiftieth percentile of
the published compensation survey data previously described.
Annual Performance-Based Incentives
Under the Company's 1998 annual incentive strategy, executive target awards
were set to bring total annual compensation to the seventy-fifth percentile of
the market survey data upon achievement of target performance. The strategy was
structured so that 60 percent of annual incentive award opportunities were tied
to corporate performance for corporate positions (and for business unit
positions, a combination of corporate and business unit performance) and 40
percent of the award opportunities were tied to a qualitative assessment of
individual performance.
The corporate financial objectives for 1998 were total shareholder return
compared to the industry peers shown in the Performance Graph and earnings
before interest expense, income taxes and depreciation, depletion and
amortization ("EBITDA") relative to the Company's business plan. These measures
were weighted equally. For business unit positions, the quantitative performance
measures, also weighted equally, were return on capital employed and EBITDA
relative to the business plan.
The individual, subjective performance measures for executive officers
included such measures as acquisitions success, strategy development and
organizational development. In addition to these measures, business unit
positions were also evaluated on various cost, safety, environmental, operating
and strategy implementation objectives. These objectives were not weighted.
Annual incentive awards in 1998 for executive officers were paid between target
and maximum levels based on the Company's results and individual performance.
Payouts for business unit officers also fell between target and maximum based on
combined corporate and unit results.
Long-Term Incentives
The Company believes that its executive officers should have an ongoing
stake in the success of the Company. The Company also believes these key
employees should have a considerable portion of their total compensation tied to
the Company's stock price performance since stock-related compensation is
directly tied to shareholder value.
In 1998, the Compensation Committee provided stock option grants to key
executives and selected other employees under its ongoing long-term incentive
program. Stock options provide a strong tie between pay and performance, since
recipients realize value from stock options only if the Company's share price
rises above the grant price. Stock options were granted to executive officers in
October 1998 at a price equal to the public offering price ($15.9375) of a share
of the Company's Common Stock on July 1, 1998. This grant price ($15.9375) was
above the market price ($14.50) for the Company's Common Stock on the date of
grant of these options.
In determining the size of stock option grants for executive officers in
1998, the Compensation Committee considered market data on typical stock option
grants at the market twenty-fifth, fiftieth and seventy-fifth percentiles. The
1998 stock option grants made to executives generally ranged between the
16
<PAGE> 19
twenty-fifth and fiftieth percentiles based on the Chief Executive Officer's and
Compensation Committee's assessment of the participant's ability to affect
long-term results. The Compensation Committee considered the Company's total
compensation program award opportunities in determining the size of these
grants.
In addition to its ongoing stock option program, the Company had a special
incentive compensation strategy comprised of performance-vested restricted
stock/stock option for the executive officers which was established in 1996. The
intent of this strategy was to provide an extraordinary incentive for achieving
outstanding stock price performance. Under this strategy, executive officers
received from the Company's Amended and Restated Executive Long-Term Plan a
significant number of restricted shares (for three of the named executive
officers) or stock options (for other executive officers) which vested only if
the Company's share price reached an average of $20 or higher over any 20
consecutive trading days after June 30, 1997, and before December 31, 1998. The
intent of this strategy was to provide market ninetieth percentile total pay if
the Company achieved outstanding stock price growth. Awards under this strategy
vested in May 1998 since the $20 share price target was achieved.
In order to continue the focus on achieving extraordinary stock price
growth, the Compensation Committee approved a new special long-term incentive
plan, the 1998 Performance Incentive Compensation Plan (the "1998 Performance
Plan"), to replace the previous strategy. The 1998 Performance Plan is intended
to provide market ninetieth percentile total pay if the Company achieves
outstanding share price growth and also encourages continued employment with the
Company. The 1998 Performance Plan provides awards in the form of phantom stock
for the Company's top three executive officers (including the Chief Executive
Officer) and cash bonus opportunities to other eligible employees if specified
stock price hurdles are achieved. Targeted objectives are comprised of the fair
market value of the Company's Common Stock equaling or exceeding an average of
$35 per share (the "First Performance Target") and $45 per share (the "Second
Performance Target") on any 20 consecutive trading days during a period
commencing on October 1, 1998, and ending on the earlier of September 30, 2002,
or the date on which the Second Performance Target is achieved (the "Performance
Period"). Upon achievement of the First Performance Target, 25 percent of the
awards will be earned, with payout deferred until the end of the Performance
Period. The remaining 75 percent will be earned only upon achievement of the
Second Performance Target.
Other Executive Benefits and Perquisites
The Company also provides certain benefits and perquisites to its key
executive officers. These benefits and perquisites are not tied to any formal
performance criteria and are intended to serve as part of a competitive total
compensation package. These benefits and perquisites include, but are not
limited to, supplemental retirement plans, change-in-control arrangements, and,
for three of the senior executive officers, a flexible perquisites program (with
a dollar limit placed on perquisite expenses) and employment agreements. Levels
of company benefits and perquisites for executives were in line with market
fiftieth to seventy-fifth percentile levels.
DISCUSSION OF 1998 COMPENSATION FOR THE CHIEF EXECUTIVE OFFICER
The discussion below applies to Mr. Smith's 1998 compensation.
Base Salary
Mr. Smith's annual base salary was increased from $600,000 to $700,000 in
1998. This base salary adjustment placed Mr. Smith's base salary at a level
consistent with the fiftieth percentile for the Company's comparison group in
the published compensation surveys previously described. The base salary
adjustment was intended to keep Mr. Smith's base pay at a competitive level and
reflected the Compensation Committee's subjective assessment that Mr. Smith's
performance was very strong.
Annual Incentive Award
Based on the Company's performance on the measures described under the
Annual Performance-Based Incentives section above (as well as strong individual
performance in the areas of progress in establishing the
17
<PAGE> 20
Company's strategy, taking steps to enhance shareholder value, and making
targeted acquisitions), the Compensation Committee provided Mr. Smith with an
annual incentive of $640,000 for 1998. This award was between the targeted and
maximum levels provided under the program.
Stock Options
Mr. Smith received a grant of 281,900 stock options in 1998. These stock
options were granted at a price equal to the public offering price ($15.9375) of
a share of Common Stock on July 1, 1998. This grant price ($15.9375) was above
the market price ($14.50) for the Company's Common Stock on the date of grant of
these options. These options become exercisable after one year in 25 percent
increments per year. The size of the stock option grant was established between
the twenty-fifth and fiftieth percentiles of the published compensation survey
data. The performance sensitivity of stock options is a result of options
producing income for the recipient only if the Company's stock price rises above
the grant price.
Special Incentive Strategy
Under the special incentive strategy approved by the Compensation Committee
in 1996, Mr. Smith received 200,000 shares of restricted Common Stock. Upon
achievement of the performance target in May 1998, the restrictions on this
Common Stock lapsed resulting in a long-term incentive payout to Mr. Smith
valued at $4,087,500, representing the shares of Common Stock awarded under this
special strategy times $20.4375 per share, or the average market price of the
Company's Common Stock on the day of reaching the performance target.
Under the 1998 Performance Plan, Mr. Smith received 340,000 shares of
performance-vested phantom stock in October 1998. The performance-vested phantom
stock will be earned only if specified performance targets are reached during a
period commencing on October 1, 1998, and ending on the earlier of September 30,
2002, or the date on which Second Performance Target is achieved. If the Second
Performance Target is achieved, Mr. Smith would be entitled to receive in cash
an amount equal to the number of shares of phantom stock granted to him
multiplied by the fair market value of a share of Common Stock on the last day
of the Performance Period. If the First Performance Target is attained but the
Second Performance is not attained, Mr. Smith would receive one-fourth of the
amount specified in the preceding sentence.
LIMITATION OF TAX DEDUCTION FOR EXECUTIVE COMPENSATION
Under Section 162(m) of the Internal Revenue Code, as amended, publicly
traded companies may not receive a tax deduction on non-performance based
compensation to an executive officer in excess of $1 million. The Company's
stock option grants qualify as performance-based compensation under Section
162(m). The Compensation Committee considers deductibility under Section 162(m)
with respect to other compensation arrangements with executive officers.
However, the Compensation Committee and the Board believe that it is in the best
interest of the Company that the Compensation Committee retain its flexibility
and discretion to make compensation awards, whether or not deductible, in order
to foster achievement of performance goals established by the Compensation
Committee and other corporate goals that the Compensation Committee deems
important to the Company's success, such as encouraging employee retention and
rewarding achievement.
COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS
Raymond K. Mason, Sr., Chairman
Steven H. Grapstein
William J. Johnson
Alan J. Kaufman
Patrick J. Ward
Approved: July 30, 1999
18
<PAGE> 21
PERFORMANCE GRAPH
The Stock Price Performance Graph below compares the cumulative total
return of the Company's Common Stock to the cumulative total return of the S&P
500 Composite Index and to a composite peer group of companies. The composite
peer group (the "Peer Group") included the following: Holly Corporation; Murphy
Oil Corporation; Oryx Energy Company; Seagull Energy Corporation (name changed
to Ocean Energy, Inc.); Tosco Corporation; Ultramar Diamond Shamrock
Corporation; and Valero Energy Corporation. The Peer Group also included the
following companies that were merged or acquired during 1998: The Louisiana Land
and Exploration Company (merged into Burlington Resources Inc.); MAPCO Inc.
(merged into The Williams Companies Inc.); Quaker State Corporation (merged into
Pennzoil-Quaker State Co.); and Union Texas Petroleum Holdings, Inc. (merged
into Atlantic Richfield Co.). The line graph below is for the period of five
fiscal years commencing December 31, 1993, and ending December 31, 1998.
[PERFORMANCE GRAPH]
COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN*
AMONG THE COMPANY, S&P 500 INDEX AND A COMPOSITE PEER GROUP
<TABLE>
<CAPTION>
12/31/93 12/31/94 12/31/95 12/31/96 12/31/97 12/31/98
<S> <C> <C> <C> <C> <C> <C>
Tesoro Petroleum Corp....................................... $100 $168.18 $156.82 $254.55 $281.82 $220.45
S&P 500 Index............................................... $100 $101.32 $139.40 $171.40 $228.59 $293.91
Peer Group.................................................. $100 $ 98.19 $112.51 $149.12 $183.41 $142.37
</TABLE>
- ---------------
* Assumes that the value of the investment in Common Stock and each index was
$100 on December 31, 1993, and that all dividends were reinvested. Investment
is weighted on the basis of market capitalization.
NOTE: The stock price performance shown on the graph is not necessarily
indicative of future price performance.
RETIREMENT BENEFITS
The Company maintains a noncontributory qualified Retirement Plan which
covers officers and other eligible employees. Benefits under the plan are
payable on a straight life annuity basis and are based on the average monthly
earnings and years of service of participating employees. Average monthly
earnings used in calculating retirement benefits are primarily salary and bonus
received by the participating employee during the 36 consecutive months of the
last 120 months of service which produces the highest average monthly rate of
earnings.
19
<PAGE> 22
In addition, the Company maintains an unfunded executive security plan, the
Amended Executive Security Plan ("Amended Plan"), for executive officers and
other key personnel selected by the Chief Executive Officer. The Amended Plan
provides for a monthly retirement income payment during retirement equal to a
percentage of a participant's Earnings. "Earnings" is defined under the Amended
Plan to mean a participant's average monthly rate of total compensation,
primarily salary and bonus earned, including performance bonuses and incentive
compensation paid after December 1, 1993, in the form of stock awards of the
Company's Common Stock (excluding stock awards under the special incentive
compensation strategy and contingent awards under the 1998 Performance Plan),
for the 36 consecutive calendar months within the last ten-year period which
produce the highest average monthly rate of compensation for the participant.
The monthly retirement benefit percentage is defined as the sum of 4 percent of
Earnings for each of the first ten years of employment, plus 2 percent of
Earnings for each of the next ten years of employment, plus 1 percent of
Earnings for each of the next ten years of employment. The maximum percentage is
70 percent. The Amended Plan provides for the payment of the difference, if any,
between (a) the total retirement income payment calculated above and (b) the sum
of retirement income payments from the Company's Retirement Plan and Social
Security benefits.
The Company also maintains the Funded Executive Security Plan ("Funded
Plan") which covers only selected persons approved by the Chief Executive
Officer, who are also participants in the Amended Plan, and provides
participants with substantially the same aftertax benefits as the Amended Plan.
Advance payments are made to the extent a participant is expected to incur a
pre-retirement tax liability as a result of his participation in the Funded
Plan. The Funded Plan is funded separately for each participant on an
actuarially determined basis through a bank trust whose primary asset is an
insurance contract providing for a guaranteed rate of return for certain
periods. Amounts payable to participants from the Funded Plan reduce amounts
otherwise payable under the Amended Plan.
The following table shows the estimated annual benefits payable upon
retirement under the Company's Retirement Plan, Amended Plan and the Funded Plan
for employees in specified compensation and years of benefit service
classifications without reference to any amount payable upon retirement under
the Social Security law or any amount advanced before retirement. The estimated
annual benefits shown are based upon the assumption that the plans continue in
effect and that the participant receives payment for life. For limitation years
ending with or within calendar year 1998 or 1999, the federal tax law generally
limits maximum annual retirement benefits payable by the Retirement Plan to any
employee to $130,000, adjusted annually to reflect increases in the cost of
living and adjusted actuarially for retirement. However, since the Amended Plan
and the Funded Plan are not qualified under Section 401 of the Internal Revenue
Code of 1986, as amended (the "Code"), it is possible for certain retirees to
receive annual benefits in excess of this tax limitation.
<TABLE>
<CAPTION>
HIGHEST AVERAGE NUMBER OF YEARS OF BENEFIT SERVICE
ANNUAL RATE -----------------------------------------
OF COMPENSATION 10 15 20 25
--------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
$ 100,000.......................................... $ 40,000 $ 50,000 $ 60,000 $ 65,000
$ 200,000.......................................... $ 80,000 $100,000 $120,000 $130,000
$ 300,000.......................................... $120,000 $150,000 $180,000 $195,000
$ 400,000.......................................... $160,000 $200,000 $240,000 $260,000
$ 500,000.......................................... $200,000 $250,000 $300,000 $325,000
$ 600,000.......................................... $240,000 $300,000 $360,000 $390,000
$ 700,000.......................................... $280,000 $350,000 $420,000 $455,000
$ 800,000.......................................... $320,000 $400,000 $480,000 $520,000
$ 900,000.......................................... $360,000 $450,000 $540,000 $585,000
$1,000,000......................................... $400,000 $500,000 $600,000 $650,000
$1,100,000......................................... $440,000 $550,000 $660,000 $715,000
$1,200,000......................................... $480,000 $600,000 $720,000 $780,000
$1,300,000......................................... $520,000 $650,000 $780,000 $845,000
</TABLE>
20
<PAGE> 23
The years of benefit service as of December 31, 1998, for the named
executive officers were as follows: Mr. Smith, 6 years; Mr. Van Kleef, 5 years;
Mr. Reed, 24 years; Mr. Wormington, 4 years; and Mr. Oliver, 3 years.
In addition to the retirement benefits described above, the Amended Plan
provides for a pre-retirement death benefit payable over eight years of four
times a participant's annual base pay as of December 1 preceding a participant's
date of death, less the amount payable from the Funded Plan at the date of
death. The amount payable from the Funded Plan at death is based on the
actuarial value of the participant's vested accrued benefit, payable in 96
monthly installments or as a life annuity if a surviving spouse is the
designated beneficiary.
EMPLOYMENT CONTRACTS, MANAGEMENT STABILITY AGREEMENTS AND CHANGE-IN-CONTROL
ARRANGEMENTS
Under an amendment effective October 28, 1998 to an employment agreement
dated November 1, 1997, Mr. Smith is employed until November 1, 2000, at an
annual base salary of $700,000. Under separate employment agreements, Mr. Van
Kleef and Mr. Reed are employed until October 28, 2000, at annual base salaries
of $450,000 and $350,000, respectively. In addition to their base salaries, each
of the employment agreements for the above executives provides that the Company
shall establish an annual incentive compensation strategy for executive officers
in which each executive shall be entitled to participate in a manner consistent
with his position with the Company and the evaluations of his performance by the
Board of Directors or any appropriate committee thereof. The target incentive
bonus under the 1998 annual incentive compensation strategy was a percentage of
the respective executive officer's annual base salary and was 100 percent for
Mr. Smith, 90 percent for Mr. Van Kleef and 75 percent for Mr. Reed. Each of the
employment agreements also provides that the executive will receive an annual
amount ("flexible perquisite amount") to cover various business-related expenses
such as dues for country, luncheon or social clubs; automobile expenses; and
financial and tax planning expenses. The executive may elect at any time by
written notice to the Company to receive in cash any of such flexible perquisite
amount which has not been paid to or on behalf of the executive. The annual
flexible perquisite amount is $30,000, $20,000 and $20,000 for Mr. Smith, Mr.
Van Kleef and Mr. Reed, respectively. Each employment agreement also provides
that the Company will pay initiation fees for social clubs and reimburse the
executive for related tax expenses to the extent the Board of Directors, or a
duly authorized committee thereof, determines such fees are reasonable and in
the best interest of the Company.
Each of the employment agreements with Mr. Smith, Mr. Van Kleef and Mr.
Reed provides that in the event the Company should terminate such executive
officer's employment without cause, if he should resign his employment for "good
reason" (as "good reason" is defined in the employment agreements), or if the
Company shall not have offered to such executive officer prior to the
termination date of his employment agreement the opportunity to enter into a new
employment agreement, with terms, in all respects, no less favorable to the
executive than the terms of his current employment agreement, such executive
will be paid a lump-sum payment equal to (i) two times the sum of (a) his base
salary at the then current rate and (b) the sum of the target bonuses under all
of the Company's incentive bonus plans applicable to such executive for the year
in which the termination occurs and (ii) if termination occurs in the fourth
quarter of a calendar year, the sum of the target bonuses under all of the
Company's incentive bonus plans applicable to such executive for the year in
which the termination occurs prorated daily based on the number of days from the
beginning of the calendar year in which the termination occurs to and including
the date of termination. Each executive shall also receive all unpaid bonuses
for the year prior to the year in which the termination occurs and shall receive
(i) for a period of two years continuing coverage and benefits comparable to all
life, health and disability insurance plans which the Company from time to time
makes available to its management executives and their families, (ii) a lump-sum
payment equal to two times the flexible perquisites amount and (iii) two years
additional service credit under the Amended Plan and the Funded Plan, or
successors thereto, of the Company applicable to such executive on the date of
termination. All unvested stock options held by the executive on the date of the
termination shall become immediately vested and all restrictions on "restricted
stock" then held by the executive shall terminate, except for awards under the
1998 Performance Plan.
21
<PAGE> 24
Each employment agreement further provides that, in the event such
executive officer's employment is involuntarily terminated within two years of a
change of control or if the executive officer's employment is voluntarily
terminated within two years of a change of control "for good reason," as defined
in each of the employment agreements, he shall be paid within ten days of such
termination (i) a lump-sum payment equal to three times his base salary at the
then current rate; (ii) a lump-sum payment equal to the sum of (a) three times
the sum of the target bonuses under all of the Company's incentive bonus plans
applicable to such executive for the year in which the termination occurs or the
year in which the change of control occurred, whichever is greater, and (b) if
termination occurs in the fourth quarter of a calendar year, the sum of the
target bonuses under all of the Company's incentive bonus plans applicable to
such executive for the year in which the termination occurs prorated daily based
on the number of days from the beginning of the calendar year in which the
termination occurs to and including the date of termination; and (iii) a
lump-sum payment equal to the amount of any accrued but unpaid bonuses. The
Company (or its successor) shall also provide (i) for a period of three years
continuing coverage and benefits comparable to all life, health and disability
plans of the Company in effect at the time a change of control is deemed to have
occurred; (ii) a lump-sum payment equal to three times the flexible perquisites
amount; and (iii) three years additional service credit under the Amended Plan
and the Funded Plan, or successors thereto, of the Company applicable to such
executive on the date of termination. A change in control shall be deemed to
have occurred if (i) there shall be consummated (a) any consolidation or merger
of the Company in which the Company is not the continuing or surviving
corporation or pursuant to which shares of the Company's Common Stock would be
converted into cash, securities or other property, other than a merger of the
Company where a majority of the Board of Directors of the surviving corporation
are, and for a two-year period after the merger continue to be, persons who were
directors of the Company immediately prior to the merger or were elected as
directors, or nominated for election as director, by a vote of at least
two-thirds of the directors then still in office who were directors of the
Company immediately prior to the merger, or (b) any sale, lease, exchange or
transfer (in one transaction or a series of related transactions) of all or
substantially all of the assets of the Company, or (ii) the shareholders of the
Company shall approve any plan or proposal for the liquidation or dissolution of
the Company, or (iii) (A) any "person" (as such term is used in Sections 13(d)
and 14(d)(2) of the Exchange Act) other than the Company or a subsidiary thereof
or any employee benefit plan sponsored by the Company or a subsidiary thereof,
shall become the beneficial owner (within the meaning of Rule 13d-3 under the
Exchange Act) of securities of the Company representing 20 percent or more of
the combined voting power of the Company's then outstanding securities
ordinarily (and apart from rights accruing in special circumstances) having the
right to vote in the election of directors, as a result of a tender or exchange
offer, open market purchases, privately negotiated purchases or otherwise, and
(B) at any time during a period of two years thereafter, individuals who
immediately prior to the beginning of such period constituted the Board of
Directors of the Company shall cease for any reason to constitute at least a
majority thereof, unless the election or the nomination by the Board of
Directors for election by the Company's shareholders of each new director during
such period was approved by a vote of at least two-thirds of the directors then
still in office who were directors at the beginning of such period.
Each employment agreement further provides that if remuneration or benefits
of any form paid to them by the Company or any trust funded by the Company
during or after their employment with the Company are excess parachute payments
as defined in Section 280G of the Code, and are subject to the 20 percent excise
tax imposed by Section 4999 of the Code, the Company shall pay Mr. Smith, Mr.
Van Kleef and Mr. Reed a bonus no later than seven days prior to the due date
for the excise tax return in an amount equal to the excise tax payable as a
result of the excess parachute payment and any additional federal income taxes
(including any additional excise taxes) payable by them as a result of the
bonus, assuming that they will be subject to federal income taxes at the highest
individual margin rate.
The Company has separate Management Stability Agreements ("Stability
Agreements") with Mr. Wormington and Mr. Oliver which are only operative in the
event of a change of control of the Company. The Stability Agreements provide
that, if Mr. Wormington's or Mr. Oliver's employment is involuntarily terminated
within two years of a change of control or if Mr. Wormington's or Mr. Oliver's
employment is voluntarily terminated within two years of a change of control
"for good reason," as defined in the Stability Agreements, he shall be paid
within ten days of such termination (i) a lump-sum payment equal to two times
22
<PAGE> 25
his base salary at the then current rate and (ii) a lump-sum payment equal to
the sum of (a) two times the sum of the target bonuses under all of the
Company's incentive bonus plans applicable to Mr. Wormington and Mr. Oliver for
the year in which the termination occurs or the year in which the change of
control occurred, whichever is greater, and (b) if termination occurs in the
fourth quarter of a calendar year, the sum of the target bonuses under all of
the Company's incentive bonus plans applicable to Mr. Wormington and Mr. Oliver
for the year in which the termination occurs prorated daily based on the number
of days from the beginning of the calendar year in which the termination occurs
to and including the date of termination. The Company (or its successor) shall
also provide continuing coverage and benefits comparable to all life, health and
disability plans of the Company for a period of 24 months from the date of
termination and Mr. Wormington and Mr. Oliver would each receive two years
additional service credit under the Amended Plan and the Funded Plan, or
successors thereto, of the Company applicable to such executive on the date of
termination. A change of control shall be deemed to have occurred if (i) there
shall be consummated (a) any consolidation or merger of the Company in which the
Company is not the continuing or surviving corporation or pursuant to which
shares of the Company's Common Stock would be converted into cash, securities or
other property, other than a merger of the Company where a majority of the Board
of Directors of the surviving corporation are, and for a two-year period after
the merger continue to be, persons who were directors of the Company immediately
prior to the merger or were elected as directors, or nominated for election as
director, by a vote of at least two-thirds of the directors then still in office
who were directors of the Company immediately prior to the merger, or (b) any
sale, lease, exchange or transfer (in one transaction or a series of related
transactions) of all or substantially all of the assets of the Company, or (ii)
the shareholders of the Company shall approve any plan or proposal for the
liquidation or dissolution of the Company, or (iii) (A) any "person" (as such
term is used in Sections 13(d) and 14(d)(2) of the Exchange Act) other than the
Company or a subsidiary thereof or any employee benefit plan sponsored by the
Company or a subsidiary thereof, shall become the beneficial owner (within the
meaning of Rule 13d-3 under the Exchange Act) of securities of the Company
representing 20 percent or more of the combined voting power of the Company's
then outstanding securities ordinarily (and apart from rights accruing in
special circumstances) having the right to vote in the election of directors, as
a result of a tender or exchange offer, open market purchases, privately
negotiated purchases or otherwise, and (B) at any time during a period of one
year thereafter, individuals who immediately prior to the beginning of such
period constituted the Board of Directors of the Company shall cease for any
reason to constitute at least a majority thereof, unless the election or the
nomination by the Board of Directors for election by the Company's shareholders
of each new director during such period was approved by a vote of at least
two-thirds of the directors then still in office who were directors at the
beginning of such period, or (iv) there shall be, in the cases of Mr. Wormington
or Mr. Oliver, the Company's refining and marketing business or exploration and
production business, respectively, (A) a direct or indirect sale of all or
substantially all of the assets of the Company's refining and marketing business
or exploration and production business, or (B) the sale of stock of a subsidiary
(or affiliate) of the Company that conducts all or substantially all of the
Company's refining and marketing business or exploration and production
business, or (C ) a merger, joint venture or other business combination
involving the Company's refining and marketing business or exploration and
production business, and as a result of such sale of assets, sale of stock,
merger, joint venture or other business combination, the Company shall cease to
have the power to elect a majority of the Board of Directors (or the other
equivalent governing or managing body) of the entity which acquires, or
otherwise controls or conducts, the Company's refining and marketing business or
exploration and production business.
In order to participate in the 1998 Performance Plan, the parties to the
employment agreements and management stability agreements described above are
required to acknowledge that the rights and benefits under the 1998 Performance
Plan shall not be deemed an "incentive bonus plan" or other bonus or
compensation arrangement which shall be accelerated, multiplied or otherwise
required to be provided or enhanced under the employment agreement or management
stability agreement.
23
<PAGE> 26
2. APPOINTMENT OF AUDITORS
The Board of Directors considers it desirable that its appointment of the
firm of Deloitte & Touche LLP as independent auditors for the Company and its
subsidiaries for fiscal year 1999 be ratified by the stockholders.
Representatives of Deloitte & Touche LLP are expected to be present at the 1999
Annual Meeting of Stockholders and to be available to respond to appropriate
questions. Such representatives will have the opportunity to make a statement at
the annual meeting if they desire to do so. Under Delaware law, the Restated
Certificate of Incorporation and By-laws, a majority of the votes cast are
required to approve the appointment of Deloitte & Touche LLP as auditors.
Abstentions and Broker Non-Votes are not votes "cast" on the question and
therefore will not count as votes for or against the proposal, and will not be
included in calculating the number of votes necessary for approval of the
proposal.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE APPOINTMENT OF THE FIRM
OF DELOITTE & TOUCHE LLP AS INDEPENDENT AUDITORS FOR THE COMPANY AND ITS
SUBSIDIARIES FOR FISCAL YEAR 1999.
3. EXPENSES OF SOLICITATION
The Company expects to solicit proxies primarily by mail, but directors,
officers and regular employees of the Company may also solicit in person, by
telephone or telegram. All expenses in connection with the solicitation of
proxies will be borne by the Company. Arrangements will be made by the Company
for the forwarding, at the Company's expense, of soliciting materials by
brokers, nominees, fiduciaries and other custodians to their principals. The
Company has retained a professional proxy soliciting organization, Innisfree M&A
Incorporated, to aid in the solicitation of proxies from brokers, bank nominees
and other institutional owners, and possibly individual holders of record of
1,000 shares or more, by personal interview, telephone, telegram or mail. The
Company will pay such organization its customary fees, estimated not to exceed
$8,500, and will reimburse such organization for certain expenses.
4. STOCKHOLDERS' PROPOSALS
Proposals of stockholders to be presented at the annual meeting to be held
in 2000 must be received for inclusion in the Company's proxy statement and form
of proxy by April 16, 2000.
5. OTHER MATTERS
As of the date of this Proxy Statement, management of the Company has no
knowledge of any matters to be presented for consideration at the meeting other
than those referred to above. If any other matters properly come before the
meeting, the persons named in the accompanying form of proxy intend to vote such
proxy to the extent entitled in accordance with their best judgment.
By Order of the Board of Directors,
JAMES C. REED, JR.
Secretary
August 16, 1999
24
<PAGE> 27
TESORO PETROLEUM CORPORATION
APPENDIX A
TO THE PROXY STATEMENT FOR THE
1999 ANNUAL MEETING OF STOCKHOLDERS
<PAGE> 28
APPENDIX A
In accordance with Rule 14a-3(c) under the Securities Exchange Act of 1934
(the "Exchange Act"), as adapted to the "Summary Annual Report" procedure, this
Appendix and the information contained herein is taken from the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1998 and is provided
solely for the information of stockholders and the Securities and Exchange
Commission. Such information shall not be deemed to be "soliciting material" or
to be "filed" with the Securities and Exchange Commission or subject to
Regulations 14A and 14C under the Exchange Act (except as provided in Rule
14a-3) or to the liabilities of Section 18 of the Exchange Act.
The information contained in this Appendix contains statements with respect
to the Company's expectations or beliefs as to future events. These type of
statements are forward-looking and subject to uncertainties. See
"Forward-Looking Statements" on pages A-22 and A-23.
FORM 10-K
THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER
31, 1998, HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. A COPY OF
THIS REPORT MAY BE OBTAINED FREE OF CHARGE FROM CORPORATE COMMUNICATIONS, TESORO
PETROLEUM CORPORATION, 8700 TESORO DRIVE, SAN ANTONIO, TEXAS 78217-6218,
TELEPHONE: (800) 837-6768.
INDEX TO APPENDIX A
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
I. Selected Financial Data..................................... A-3
II. Management's Discussion and Analysis of Financial Condition
and Results of Operations:
General..................................................... A-5
Business Environment........................................ A-6
Results of Operations....................................... A-7
Capital Resources and Liquidity............................. A-16
Forward-Looking Statements.................................. A-22
III. Quantitative and Qualitative Disclosures About Market
Risk................................................... A-23
IV. Financial Statements:
Independent Auditors' Report................................ A-25
Statements of Consolidated Operations -- Years Ended
December 31, 1998, 1997 and 1996....................... A-26
Consolidated Balance Sheets -- December 31, 1998 and 1997... A-27
Statements of Consolidated Stockholders' Equity -- Years
Ended December 31, 1998, 1997 and 1996................. A-28
Statements of Consolidated Cash Flows -- Years Ended
December 31, 1998, 1997 and 1996....................... A-29
Notes to Consolidated Financial Statements.................. A-30
</TABLE>
A-2
<PAGE> 29
I. SELECTED FINANCIAL DATA
The selected consolidated financial data should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Company's Consolidated Financial Statements, including the
notes thereto, included in this Appendix. Financial results of acquired entities
in the Refining and Marketing segment during 1998 and the Marine Services
segment during 1996 have been included in the amounts below since their
respective acquisitions date (see Note C of Notes to Consolidated Financial
Statements).
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------
1998 1997 1996 1995 1994
-------- ------ -------- -------- ------
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
REVENUES
Gross Operating Revenues:
Refining and Marketing
Refined products.................................... $1,198.2 $643.7 $ 620.8 $ 664.5 $582.7
Other, primarily crude oil resales and
merchandise....................................... 69.8 77.2 124.6 106.5 104.3
Marine Services....................................... 118.6 132.2 122.5 74.5 77.9
Exploration and Production
U.S.(a)............................................. 71.5 73.6 93.8 113.0 90.6
Bolivia............................................. 10.5 11.2 13.7 11.7 13.2
-------- ------ -------- -------- ------
Total Gross Operating Revenues.................... 1,468.6 937.9 975.4 970.2 868.7
Other income(a)......................................... 21.7 5.5 64.4 32.7 3.2
-------- ------ -------- -------- ------
Total Revenues.................................... $1,490.3 $943.4 $1,039.8 $1,002.9 $871.9
======== ====== ======== ======== ======
SEGMENT OPERATING PROFIT (LOSS)(b)
Refining and Marketing................................ $ 69.7 $ 20.5 $ 6.0 $ 0.7 $ 2.4
Marine Services....................................... 8.6 6.3 6.1 (4.4) (2.3)
Exploration and Production
U.S. before write-down(a)........................... 45.9 37.3 123.9 102.0 55.0
Bolivia before write-down........................... 3.4 8.6 8.8 7.6 9.3
Write-downs of oil and gas properties(c)............ (68.3) -- -- -- --
-------- ------ -------- -------- ------
Total Segment Operating Profit.................... $ 59.3 $ 72.7 $ 144.8 $ 105.9 $ 64.4
======== ====== ======== ======== ======
EARNINGS (LOSS) BEFORE EXTRAORDINARY ITEM............... $ (15.0) $ 30.7 $ 76.8 $ 57.5 $ 20.5
EXTRAORDINARY LOSS ON DEBT EXTINGUISHMENTS, NET OF
INCOME TAXES(d)....................................... (4.4) -- (2.3) (2.9) (4.8)
-------- ------ -------- -------- ------
NET EARNINGS (LOSS)..................................... (19.4) 30.7 74.5 54.6 15.7
PREFERRED DIVIDEND REQUIREMENTS......................... 6.0 -- -- -- 2.7
-------- ------ -------- -------- ------
NET EARNINGS (LOSS) APPLICABLE TO COMMON STOCK.......... $ (25.4) $ 30.7 $ 74.5 $ 54.6 $ 13.0
======== ====== ======== ======== ======
NET EARNINGS (LOSS) PER SHARE -- BASIC(d)............... $ (0.86) $ 1.16 $ 2.87 $ 2.22 $ 0.58
NET EARNINGS (LOSS) PER SHARE -- DILUTED(d)............. $ (0.86) $ 1.14 $ 2.81 $ 2.18 $ 0.56
WEIGHTED AVERAGE COMMON SHARES -- BASIC (MILLIONS)...... 29.4 26.4 26.0 24.6 22.6
WEIGHTED AVERAGE COMMON SHARES AND POTENTIALLY DILUTIVE
COMMON SHARES -- DILUTED (MILLIONS)................... 29.4 26.9 26.5 25.1 23.2
EBITDA, CONSOLIDATED(e)................................. $ 152.9 $103.8 $ 174.8 $ 127.8 $ 83.1
CASH FLOWS FROM (USED IN)
Operations............................................ $ 116.5 $ 95.6 $ 178.9 $ 35.4 $ 60.3
Investing............................................. (718.6) (151.5) (94.2) 2.4 (91.2)
Financing............................................. 606.6 41.5 (75.9) (37.8) 8.3
-------- ------ -------- -------- ------
Increase (Decrease) in Cash and Cash Equivalents.... $ 4.5 $(14.4) $ 8.8 $ -- $(22.6)
======== ====== ======== ======== ======
CAPITAL EXPENDITURES(f)
Refining and Marketing................................ $ 38.0 $ 43.9 $ 11.1 $ 9.3 $ 32.0
Marine Services....................................... 4.2 9.4 6.9 0.4 0.2
Exploration and Production
U.S. ............................................... 87.5 65.4 59.7 49.6 65.6
Bolivia............................................. 47.6 27.5 6.9 3.8 --
Other................................................. 7.8 1.3 0.4 0.8 1.8
-------- ------ -------- -------- ------
Total Capital Expenditures.......................... $ 185.1 $147.5 $ 85.0 $ 63.9 $ 99.6
======== ====== ======== ======== ======
</TABLE>
A-3
<PAGE> 30
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------
1998 1997 1996 1995 1994
-------- ------ -------- -------- ------
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Current Assets........................................ $ 390.6 $181.8 $ 237.3 $ 182.5 $182.1
Property, Plant and Equipment, Net.................... $ 894.6 $413.8 $ 316.5 $ 261.7 $273.3
Total Assets.......................................... $1,428.4 $627.8 $ 582.6 $ 519.2 $484.4
Current Liabilities................................... $ 208.2 $107.5 $ 137.8 $ 105.0 $ 96.2
Total Long-Term Debt and Other Obligations(g)......... $ 543.9 $132.3 $ 89.3 $ 164.5 $199.6
Stockholders' Equity(g)(h)............................ $ 559.2 $333.0 $ 304.1 $ 216.5 $160.7
Current Ratio......................................... 1.9:1 1.7:1 1.7:1 1.7:1 1.9:1
Working Capital....................................... $ 182.4 $ 74.3 $ 99.5 $ 77.5 $ 85.9
Total Debt to Capitalization(g)....................... 49% 28% 23% 43% 55%
Common Stock Outstanding (million shares)(g)(h)....... 32.3 26.3 26.4 24.8 24.4
Book Value Per Common Share........................... $ 12.19 $12.66 $ 11.51 $ 8.74 $ 6.59
</TABLE>
- ---------------
(a) In the Exploration and Production segment, operating profit included income
of $21.3 million in 1998 from an operator in the Bob West Field,
representing funds no longer needed as a contingency reserve for litigation;
$60 million in 1996 from termination of a natural gas contract; and a gain
in 1995 of $33 million from the sale of certain interests in the Bob West
Field. In addition, operating profit included $25 million, $47 million and
$39 million in 1996, 1995 and 1994, respectively, from the excess of the
natural gas contract prices over spot market prices.
(b) Segment operating profit (loss) equals gross operating revenues, gains and
losses on asset sales and other income less applicable segment costs of
sales, operating expenses, depreciation, depletion and other items. Income
taxes, interest expense and corporate general and administrative and other
expenses are not included in determining segment operating profit. In 1998,
a charge of $19.9 million for special incentive compensation, of which $7.9
million related to operating segments, was classified as corporate other
expense and not charged to segment operating profit. See Notes E, F and L of
Notes to Consolidated Financial Statements.
(c) In 1998, write-downs of oil and gas properties were $68.3 million ($28.4
million in the U.S. and $39.9 million in Bolivia), or $43.2 million ($1.47
per basic share) aftertax.
(d) Extraordinary losses on debt extinguishments, net of income tax benefits,
were $4.4 million ($0.15 per basic and diluted share), $2.3 million ($0.09
per basic and diluted share), $2.9 million ($0.12 per basic share, $0.11 per
diluted share) and $4.8 million ($0.21 per basic and diluted share) in 1998,
1996, 1995 and 1994, respectively. See Note D of Notes to Consolidated
Financial Statements.
(e) EBITDA represents earnings before extraordinary items, interest expense,
income taxes and depreciation, depletion and amortization (including oil and
gas property write-downs in 1998). While not purporting to reflect any
measure of the Company's operations or cash flows, EBITDA is presented for
additional analysis. Prior period amounts have been restated to conform with
current presentation.
(f) Excluding amounts to fund acquisitions in the Refining and Marketing and
Marine Services segments.
(g) In conjunction with the acquisitions in 1998, the Company refinanced its
existing indebtedness and issued senior subordinated notes and additional
equity securities, including $165 million of 7.25% Mandatorily Convertible
Preferred Stock which is included in stockholders' equity. See Note D of
Notes to Consolidated Financial Statements.
(h) The Company has not paid dividends on its Common Stock since 1986.
A-4
<PAGE> 31
II. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Those statements in the Management's Discussion and Analysis that are not
historical in nature should be deemed forward-looking statements that are
inherently uncertain. See "Forward-Looking Statements" on pages A-22 and A-23
for discussion of the factors which could cause actual results to differ
materially from those projected in such statements.
GENERAL
The Company's strategy is to (i) maximize earnings, cash flows and return
on capital employed and increase the competitiveness of each of its business
units by reducing costs, increasing operating efficiencies and optimizing
existing assets and (ii) expand its overall market presence through a
combination of internal growth initiatives and selective acquisitions which are
both accretive to earnings and provide significant operational synergies. The
Company plans to further improve profitability in the Refining and Marketing
segment by enhancing processing capabilities, strengthening marketing channels
and improving supply and transportation functions. Improved profitability has
positioned the Marine Services segment to participate in the consolidation of
the industry by pursuing opportunities for expansion, as well as optimizing
existing operations. In the Exploration and Production segment, the strategy
focuses on generating and operating exploration projects in an effort to
diversify its oil and gas production and reserve base. Selectively, the Company
uses acquisitions and enhanced technical capabilities. The Company has made
significant progress in diversifying its U.S. operations to areas other than the
Bob West Field and has taken steps to begin serving emerging markets in South
America.
As part of this strategy, the Company completed the following Refining and
Marketing acquisitions during 1998:
- On May 29, 1998, the Company completed the acquisition (the "Hawaii
Acquisition") of all of the outstanding capital stock of BHP Petroleum
Americas Refining Inc. and BHP Petroleum South Pacific Inc. (together,
"BHP Hawaii") from BHP Hawaii Inc. and BHP Petroleum Pacific Islands
Inc., affiliates of The Broken Hill Proprietary Company Limited ("BHP").
The Hawaii Acquisition included a 95,000-barrel per day refinery (the
"Hawaii Refinery") and 32 retail gasoline stations located in Hawaii.
Tesoro paid $252.2 million in cash for the Hawaii Acquisition, including
$77.2 million for working capital. In addition, Tesoro issued an
unsecured, non-interest bearing, promissory note for the purchase in the
amount of $50 million, payable in five equal annual installments of $10
million each, beginning in 2009.
- On August 10, 1998, the Company completed the acquisition (the
"Washington Acquisition" and together with the Hawaii Acquisition, the
"Acquisitions") of all of the outstanding stock of Shell Anacortes
Refining Company ("Shell Washington"), an affiliate of Shell Oil Company.
The Washington Acquisition included a 108,000-barrel per day refinery
(the "Washington Refinery") in Anacortes, Washington and related assets.
The total cash purchase price for the Washington Acquisition was $280.1
million, including $43.1 million for working capital.
The Acquisitions are expected to triple Tesoro's historical annual revenues
and significantly increase the scope of its refining and marketing operations.
The Acquisitions had a positive impact on earnings and cash flows in the fourth
quarter of 1998, and management expects that the Acquisitions will add to
earnings and cash flows in 1999. Management believes that there are significant
cost-saving and revenue-enhancement opportunities available by integrating the
Hawaii and Washington refineries with the Alaskan operations and has identified
approximately $25 million of potential annual cost saving and revenue enhancing
synergies. Management expects to realize the full annual impact of such
synergies during 1999. The Company will continue to pursue other opportunities
that are operationally and geographically complementary with its asset base.
In conjunction with the Acquisitions and refinancing of its then-existing
indebtedness ("Refinancing") in 1998, the Company issued equity and debt
securities providing the Company with $533 million of net proceeds
A-5
<PAGE> 32
and entered into a $500 million senior credit facility ("Senior Credit
Facility"). For information related to the financings, see Note D of Notes to
Consolidated Financial Statements.
BUSINESS ENVIRONMENT
The Company operates in an environment where its earnings and cash flows
are sensitive to volatile changes in energy prices. Fluctuations in the cost of
crude oil used for refinery feedstocks and the price of refined products can
result in changes in margins from the Refining and Marketing operations, as
prices received for refined products may or may not keep pace with changes in
crude oil costs. These energy prices, together with volume levels, also
determine the carrying value of crude oil and refined product inventory. The
Company uses the last-in, first-out ("LIFO") method of accounting for
inventories of crude oil and U.S. wholesale refined products in its Refining and
Marketing segment. This method results in inventory carrying amounts that are
less likely to represent current values and in costs of sales which more closely
represent current costs. If, however, fluctuations in market prices cause the
market value of inventories to fall below their LIFO cost, the Company would
write-down its inventories to estimated realizable value.
Changes in crude oil and natural gas prices also influence the level of
drilling activity in the Gulf of Mexico. The Company's Marine Services segment,
whose customers include offshore drilling contractors and related industries,
can be impacted by significant fluctuations in natural gas, condensate and oil
prices. The Company's Marine Services segment uses the first-in, first-out
("FIFO") method of accounting for inventories of fuels. Changes in fuel prices
can significantly impact inventory valuations and costs of sales in this
segment.
Changes in natural gas, condensate and oil prices impact revenues and the
present value of estimated future net revenues and cash flows from the Company's
Exploration and Production segment. The Company may increase or decrease its
natural gas production in response to market conditions. The carrying costs of
oil and gas assets are subject to noncash write-downs based on decreases in
natural gas and oil prices and other determining factors. In 1998, the Company
recorded a $68.3 million noncash write-down of its oil and gas properties. It is
reasonably possible that the present value of proved oil and gas reserves could
be significantly reduced during the first quarter of 1999 due to further
decreases in natural gas and oil prices since year-end. This could result in
further write-downs of the Company's oil and gas properties.
A-6
<PAGE> 33
RESULTS OF OPERATIONS
SUMMARY
Tesoro's net loss for 1998 was $19.4 million, compared with net earnings of
$30.7 million and $74.5 million in 1997 and 1996, respectively. In 1998 and
1996, the Company incurred aftertax extraordinary losses of $4.4 million and
$2.3 million, respectively, for early extinguishments of debt. Results before
extraordinary losses amounted to a loss of $15.0 million in 1998 and earnings of
$30.7 million and $76.8 million in 1997 and 1996, respectively. The net loss per
share for 1998 was $0.86 (basic and diluted) after preferred dividends, compared
with net earnings per basic share of $1.16 ($1.14 diluted) and $2.87 ($2.81
diluted) in 1997 and 1996, respectively. Significant items, including
write-downs of oil and gas properties, which affect the comparability between
results for the years ended December 31, 1998, 1997 and 1996 are highlighted in
the table below (in millions except per share amounts):
<TABLE>
<CAPTION>
1998 1997 1996
------ ----- ------
<S> <C> <C> <C>
Net earnings (loss) as reported............................. $(19.4) $30.7 $ 74.5
Extraordinary loss on debt extinguishments, net of income
tax benefit............................................... 4.4 -- 2.3
------ ----- ------
Earnings (loss) before extraordinary items.................. (15.0) 30.7 76.8
------ ----- ------
Significant items affecting comparability, pretax:
Write-downs of oil and gas properties..................... (68.3) -- --
Income from receipt of contingency funds from a U.S. gas
field operator......................................... 21.3 -- --
Charge for special incentive compensation................. (19.9) -- --
Income from settlement of a natural gas contract.......... -- -- 60.0
Operating profit from excess of natural gas contract
prices over spot market prices......................... -- -- 24.6
Other..................................................... -- 4.0 5.5
------ ----- ------
Total significant items, pretax........................ (66.9) 4.0 90.1
Income tax effect...................................... (24.6) 1.2 27.2
------ ----- ------
Total significant items, aftertax...................... (42.3) 2.8 62.9
------ ----- ------
Net earnings excluding significant items and extraordinary
items..................................................... 27.3 27.9 13.9
Preferred dividend requirements............................. 6.0 -- --
------ ----- ------
Net earnings applicable to Common Stock, excluding
significant items and extraordinary items................. $ 21.3 $27.9 $ 13.9
====== ===== ======
Earnings (loss) per share -- basic:
As reported............................................... $(0.86) $1.16 $ 2.87
Extraordinary loss........................................ (0.15) -- (0.09)
Effect of other significant items......................... (1.43) 0.10 2.43
------ ----- ------
Excluding significant items and extraordinary items....... $ 0.72 $1.06 $ 0.53
====== ===== ======
Earnings (loss) per share -- diluted:
As reported............................................... $(0.86) $1.14 $ 2.81
Extraordinary loss........................................ (0.15) -- (0.09)
Effect of other significant items......................... (1.42) 0.10 2.37
------ ----- ------
Excluding significant items and extraordinary items....... $ 0.71 $1.04 $ 0.53
====== ===== ======
</TABLE>
Excluding the significant items affecting comparability, net earnings would
have been $27.3 million in 1998, compared with net earnings of $27.9 million in
1997 and $13.9 million in 1996. Increased Refining and Marketing results in 1998
were substantially offset by higher interest and financing costs and lower
natural gas sales prices in the Exploration and Production segment. When
comparing 1997 with 1996, after excluding significant items, the $14 million
improvement in net earnings was primarily attributable to better refined product
margins, higher spot market natural gas prices and lower interest expense.
Net earnings per share, after excluding significant items, would have been
$0.72 per basic share ($0.71 diluted) for 1998, compared with $1.06 per basic
share ($1.04 diluted) in 1997 and $0.53 per basic and
A-7
<PAGE> 34
diluted share in 1996. On a per share basis, the Company's results for 1998 were
reduced by dividends on Preferred Stock and the impact of issuing additional
shares of Common Stock during the year.
The accompanying consolidated financial statements and related notes,
together with the following discussion and analysis, are intended to provide
shareholders and other investors with a reasonable basis for assessing the
Company's operations, but should not serve as the only criteria for predicting
the future performance of the Company.
REFINING AND MARKETING
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------ ------
(DOLLARS IN MILLIONS EXCEPT
PER BARREL AMOUNTS)
<S> <C> <C> <C>
GROSS OPERATING REVENUES
Refined products.......................................... $1,198.2 $643.7 $620.8
Other, primarily crude oil resales and merchandise........ 69.8 77.2 124.6
-------- ------ ------
Gross Operating Revenues............................. $1,268.0 $720.9 $745.4
======== ====== ======
SEGMENT OPERATING PROFIT
Gross margin:
Refinery(a)............................................ $ 307.3 $116.9 $ 92.4
Non-refinery, primarily merchandise(a)................. 22.6 13.0 14.9
-------- ------ ------
Total gross margin................................... 329.9 129.9 107.3
Operating expenses and other.............................. 235.1 96.7 88.8
Depreciation and amortization............................. 25.1 12.7 12.5
-------- ------ ------
Segment Operating Profit............................. $ 69.7 $ 20.5 $ 6.0
======== ====== ======
CAPITAL EXPENDITURES........................................ $ 38.0 $ 43.9 $ 11.1
======== ====== ======
REFINERY THROUGHPUT (thousand of barrels per day)(b)
Alaska.................................................... 57.6 50.2 47.5
Hawaii.................................................... 82.3 -- --
Washington................................................ 101.8 -- --
-------- ------ ------
Total Refinery Throughput............................ 241.7 50.2 47.5
======== ====== ======
REFINED PRODUCTS MANUFACTURED (thousands of barrels per
day)(b)
Gasoline and gasoline blendstocks......................... 50.9 12.8 12.8
Jet fuel.................................................. 40.6 15.4 14.0
Diesel fuel............................................... 18.8 6.2 6.0
Heavy oils and residual products.......................... 33.5 14.8 13.7
Other, including synthetic natural gas and liquefied
petroleum gas.......................................... 9.7 2.3 2.6
-------- ------ ------
Total Refined Products Manufactured.................. 153.5 51.5 49.1
======== ====== ======
REFINERY PRODUCT SPREAD ($/barrel)(a)....................... $ 5.67 $ 6.38 $ 5.33
======== ====== ======
</TABLE>
A-8
<PAGE> 35
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------ ------
(DOLLARS IN MILLIONS EXCEPT
PER BARREL AMOUNTS)
<S> <C> <C> <C>
SEGMENT PRODUCT SALES (thousands of barrels per day)(b)(c)
Gasoline and gasoline blendstocks......................... 58.4 17.4 17.4
Middle distillates........................................ 70.7 30.6 29.7
Heavy oils, residual products and other................... 38.7 17.9 15.1
-------- ------ ------
Total Product Sales.................................. 167.8 65.9 62.2
======== ====== ======
SEGMENT PRODUCT SALES PRICES ($/barrel)
Gasoline.................................................. $ 24.22 $33.71 $32.72
Middle distillates........................................ $ 19.79 $28.36 $29.01
Heavy oils and residual products.......................... $ 12.12 $17.30 $17.61
SEGMENT GROSS MARGINS ON PRODUCT SALES ($/barrel)(d)
Average sales price....................................... $ 19.56 $26.76 $27.28
Average costs of sales.................................... 14.49 21.92 23.15
-------- ------ ------
Gross Margin...................................... $ 5.07 $ 4.84 $ 4.13
======== ====== ======
</TABLE>
- ---------------
(a) Amounts reported for 1997 and 1996 have been reclassified to conform with
current presentation, primarily to reclassify retail margins and
intrasegment transportation revenues from non-refinery margin to refinery
product spread.
(b) Sales and manufactured volumes for 1998 included amounts from the acquired
Hawaii and Washington operations since the acquisition dates, averaged over
the full year. Refinery throughput for 1998 included volumes from the Hawaii
and Washington refineries, averaged over the periods owned since
acquisition.
(c) Sources of total product sales included products manufactured at the
Company's refineries, products drawn from inventory balances and products
purchased from third parties.
(d) Gross margins on product sales included margins on sales of manufactured and
purchased products and the effects of inventory changes.
1998 Compared with 1997. Segment operating profit from the Refining and
Marketing operations totaled $69.7 million in 1998, an increase of $49.2 million
from segment operating profit of $20.5 million in 1997. The increase in segment
operating profit was primarily due to higher throughput and sales volumes,
primarily from the acquired refineries (see Note C of Notes to Consolidated
Financial Statements), and improved refined product yields in Alaska. Financial
results from the acquired operations have been included since the dates of
acquisition. The Hawaii Acquisition was completed on May 29, 1998, and the
Washington Acquisition was completed on August 10, 1998. The Acquisitions
contributed positively to the segment's operating profit in 1998; however, on a
consolidated basis, these results were largely offset by corporate interest and
financing costs.
During 1998, the Company's refined product yields in Alaska benefitted from
an expansion of the hydrocracker unit completed in October 1997. The expansion,
which increased the unit's capacity by approximately 25%, enables production of
more jet fuel. Segment results were favorably impacted by this expansion
beginning in the fourth quarter of 1997. During 1998, average throughput at the
Company's Alaska refinery (the "Alaska Refinery") increased by 7,400 barrels per
day, a 15% increase over 1997 which included a 30-day maintenance turnaround.
Production of jet fuel at this refinery increased by approximately 30% over 1997
due to the hydrocracker expansion and higher throughput levels.
The Alaska hydrocracker expansion and the Acquisitions contributed to an
increase in the proportion of higher value gasoline and middle distillates
manufactured by the Company in 1998. Conversely, the proportion of lower value
heavy oils and residual products manufactured by the Company decreased in 1998.
The higher-value mix of product partly offset market pressures which decreased
year-to-year refinery product spreads to $5.67 per barrel in 1998 from $6.38 per
barrel in 1997. Increased gross margins of $5.07 per barrel in 1998, which
compare to $4.84 per barrel in 1997, reflected the higher-value mix of
manufactured product and a reduction in products purchased and resold. In 1998,
products from the Company's refineries accounted for
A-9
<PAGE> 36
approximately 91% of its sales volume, compared with 78% in 1997, enabling the
Company to reduce the amounts of products purchased from others which generally
sell at lower margins.
Revenues from sales of refined products in the Refining and Marketing
segment increased during 1998 primarily due to the higher sales volumes from the
Acquisitions, partially offset by lower sales prices. Export sales of refined
products increased to $35.5 million in 1998, compared with $16.1 million in
1997, primarily due to sales from Hawaii to Asia partly offset by a decrease in
exports from the Alaska Refinery to the Far East. Other revenues included crude
oil resales of $29.9 million in 1998 compared to $44.4 million in 1997.
Merchandise sales, also included in other revenues, increased in 1998 due to the
Hawaii Acquisition which included 30 Company-operated retail stations. The
increase in costs of sales reflected higher volumes associated with the
Acquisitions, partly offset by lower feedstock prices. Margins from non-refinery
activities increased to $22.6 million in 1998, compared with $13.0 million in
1997, primarily due to the higher merchandise sales. Operating expenses and
depreciation and amortization were higher in 1998 primarily due to the
Acquisitions.
With the acquisitions of the Hawaii and Washington refineries, enhancements
of product mix and expansion of market areas, the Company has improved the
fundamental earnings potential of this segment. Management plans to further
improve profitability by enhancing processing capabilities, strengthening
marketing channels and improving supply and transportation functions. The
ability to supply these expanded markets with a higher proportion of
manufactured products, rather than purchased products, is also expected to
improve profitability. Future profitability of this segment, however, will
continue to be influenced by market conditions, particularly as these conditions
influence costs of crude oil relative to prices received for sales of refined
products, and other additional factors that are beyond the control of the
Company.
1997 Compared with 1996. The Refining and Marketing segment's operating
profit of $20.5 million in 1997 increased $14.5 million from operating profit of
$6.0 million in 1996. The improvement was due in part to the Company's
initiatives to enhance its product slate, improve efficiencies and sell a larger
portion of the Alaska Refinery's production within the core Alaska market. The
expansion of the hydrocracker unit discussed above began to favorably impact
this segment's results in the fourth quarter of 1997. In October 1997, the
Company began purchasing approximately 25,000 barrels per day of Cook Inlet
crude oil in addition to the 9,000 barrels per day under previously existing
contracts.
During 1997, the Company's production of refined products increased by 5%.
The operational changes, discussed above, resulted in an 8% increase in the
production of higher-value middle distillates, primarily jet fuel, while
production of lower-value heavy oils, residual products and other increased by
5%. The improved product slate, which better matches the Company's product
supply with demand in Alaska, reflected a change of the hydrocracker catalyst in
late 1996, as well as the hydrocracker expansion and catalyst change in late
1997. The Company's sales of refined products within Alaska increased by 6% in
1997, contributing to higher product margins. The improved product slate and
marketing efforts, together with generally favorable industry conditions,
resulted in an increase in the Company's refinery spread to $6.38 per barrel in
1997, compared to $5.33 per barrel in 1996. Both years included scheduled 30-day
maintenance turnarounds.
Revenues from sales of refined products in the Refining and Marketing
segment increased during 1997, reflecting a 6% increase in sales volumes,
partially offset by slightly lower average sales prices. Total refined product
sales averaged 65,900 barrels per day in 1997, compared to 62,200 barrels per
day in 1996. Other revenues, which included crude oil resales of $44.4 million
in 1997 and $93.8 million in 1996, declined due to lower sales volumes and
prices. The Company had less crude oil available for resale in 1997 as
throughput at the Alaska Refinery increased by 2,700 barrels per day, or 6%,
from 1996. Export sales of refined products, including sales to Russia, amounted
to $16.1 million in 1997, compared to $22.0 million in 1996. Costs of sales
decreased in 1997 due to lower spot purchases of crude oil and lower prices.
Margins from non-refinery activities decreased to $13.0 million in 1997 due
primarily to lower margins on refined product purchased for resale. Operating
expenses and other increased 9% in 1997 due primarily to higher employee costs,
professional fees and marketing expenses.
A-10
<PAGE> 37
MARINE SERVICES
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Gross Operating Revenues
Fuels..................................................... $ 91.1 $104.5 $ 98.9
Lubricants and other...................................... 15.9 16.4 14.9
Services.................................................. 11.6 11.3 8.7
------ ------ ------
Gross Operating Revenues............................... 118.6 132.2 122.5
Costs of Sales.............................................. 79.0 96.7 93.0
------ ------ ------
Gross Profit........................................... 39.6 35.5 29.5
Operating Expenses and Other................................ 28.6 27.5 22.2
Depreciation and Amortization............................... 2.4 1.7 1.2
------ ------ ------
Segment Operating Profit............................... $ 8.6 $ 6.3 $ 6.1
====== ====== ======
Sales Volumes (millions of gallons):
Fuels, primarily diesel................................... 180.8 156.4 142.7
Lubricants................................................ 2.3 2.7 2.3
Capital Expenditures........................................ $ 4.2 $ 9.4 $ 6.9
</TABLE>
1998 Compared with 1997. Gross operating revenues decreased 10% from $132.2
million in 1997 to $118.6 million in 1998, reflecting a $13.4 million decline in
fuel revenues from lower market prices partly offset by a 16% increase in fuel
sales volumes. The increase in fuel volumes was attributable to operations in
the Gulf of Mexico and the transfer of three West Coast terminals from the
Company's Refining and Marketing segment to Marine Services in January 1998. The
decrease in costs of sales also reflected lower fuel prices, partly offset by
increased volumes. Gross profit, which improved by $4.1 million due to higher
volumes, was partly offset by additional operating expenses from the West Coast
terminals and higher depreciation and amortization resulting from upgrades to
facilities. Despite lower rig activity in the Gulf of Mexico, total segment
operating profit increased by $2.3 million largely due to the Company's ability
to emphasize customer service, control expenses and increase sales volumes.
Profitability of the Marine Services segment can be affected significantly
by the level of oil and gas drilling, workover, construction and seismic
activity in the Gulf of Mexico. With depressed oil and gas prices continuing
into 1999, exploration and production activity in the Gulf of Mexico has
significantly declined. While the Company's Marine Services segment has taken
initiatives to be a low-cost provider and has expanded its operations into the
West Coast, its operating results will be adversely impacted by reduced sales
volumes and pressure on margins in the near term.
1997 Compared with 1996. Gross operating revenues increased by $9.7
million, which included a $7.1 million increase in fuels and lubricant revenues
and a $2.6 million increase in service revenues. The increase in fuels and
lubricant revenues reflected a 10% increase in sales volumes, partially offset
by lower prices. The 30% increase in service revenue was due in part to
increased rig activity in the Gulf of Mexico and the Company's focus to serve
these customers. Additional terminal locations stemming from an acquisition in
February 1996 together with internal growth initiatives have enabled the Company
to increase its sales activity. Costs of sales increased in 1997 due to the
higher volumes. The improvement of $6.0 million in gross profit was largely
offset by higher operating and other expenses associated with the increased
activity and higher depreciation and amortization expense.
A-11
<PAGE> 38
EXPLORATION AND PRODUCTION
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
(DOLLARS IN MILLIONS
EXCEPT PER UNIT AMOUNTS)
<S> <C> <C> <C>
U.S.(a)(b)
Gross operating revenues.................................. $ 71.5 $ 73.6 $ 93.8
Other income(c)........................................... 22.4 3.2 64.8
Production costs.......................................... 9.7 7.4 5.3
Administrative support and other operating expenses....... 2.4 2.3 3.8
Depreciation, depletion and amortization.................. 35.9 29.8 25.6
Write-down of oil and gas properties...................... 28.4 -- --
------ ------ ------
Segment Operating Profit -- U.S...................... 17.5 37.3 123.9
------ ------ ------
BOLIVIA
Gross operating revenues.................................. 10.5 11.2 13.7
Other income (expense).................................... (0.5) 2.2 --
Production costs.......................................... 1.2 0.9 0.8
Administrative support and other operating expenses....... 2.8 2.4 2.8
Depreciation, depletion and amortization.................. 2.6 1.5 1.3
Write-down of oil and gas properties...................... 39.9 -- --
------ ------ ------
Segment Operating Profit (Loss) -- Bolivia........... (36.5) 8.6 8.8
------ ------ ------
TOTAL SEGMENT OPERATING PROFIT (LOSS) -- EXPLORATION AND
PRODUCTION................................................ $(19.0) $ 45.9 $132.7
====== ====== ======
U.S.
Average Daily Net Production:
Natural gas (million cubic feet, "MMcf")............... 90.5 86.1 87.7
Oil (thousand barrels)................................. 0.3 0.1 --
Total (million cubic feet equivalent, "MMcfe")......... 92.4 86.8 87.7
Average Prices:
Natural gas ($/thousand cubic feet, "Mcf")(b)(d)....... $ 2.02 $ 2.17 $ 2.75
Oil ($/barrel)......................................... $11.88 $18.90 $21.99
Average Operating Expenses ($/thousand cubic feet equivalent,
"Mcfe"):
Lease operating expenses............................... $ 0.25 $ 0.20 $ 0.14
Severance taxes........................................ 0.04 0.03 0.03
------ ------ ------
Total production costs............................... 0.29 0.23 0.17
Administrative support and other....................... 0.06 0.07 0.10
------ ------ ------
Total Operating Expenses............................. $ 0.35 $ 0.30 $ 0.27
====== ====== ======
Depletion ($/Mcfe)........................................ $ 1.04 $ 0.93 $ 0.79
Capital Expenditures (including U.S. gas
transportation)........................................ $ 87.5 $ 65.4 $ 59.7
BOLIVIA
Average Daily Net Production:
Natural gas (MMcf)..................................... 24.4 19.5 20.3
Condensate (thousand barrels).......................... 0.7 0.5 0.6
Total (MMcfe).......................................... 28.6 22.6 23.8
Average Prices:
Natural gas ($/Mcf).................................... $ 0.81 $ 1.15 $ 1.33
Condensate ($/barrel).................................. $12.80 $15.71 $17.98
Average Operating Expenses ($/Mcfe):
Production costs....................................... $ 0.11 $ 0.11 $ 0.10
Administrative support and other....................... 0.28 0.31 0.32
------ ------ ------
Total Operating Expenses............................... $ 0.39 $ 0.42 $ 0.42
====== ====== ======
Depletion ($/Mcfe)........................................ $ 0.25 $ 0.19 $ 0.15
Capital Expenditures...................................... $ 47.6 $ 27.5 $ 6.9
</TABLE>
A-12
<PAGE> 39
- ---------------
(a) Represents the Company's U.S. oil and gas operations combined with gas
transportation activities.
(b) Results for 1996 included revenues from sales of natural gas at above-market
prices under a contract with Tennessee Gas Pipeline Company ("Tennessee
Gas") which was terminated effective October 1, 1996. During 1996, the spot
market price for natural gas was $1.95 per Mcf, while the average price,
including the impact of the Tennessee Gas contract, was $2.75 per Mcf. Net
natural gas production sold under the contract averaged approximately 11
MMcf per day in 1996. Operating profit for 1996 included $24.6 million from
the excess of these contract prices over spot market prices. Upon
termination of the contract, the Company recorded other income and operating
profit of $60 million during the fourth quarter of 1996. See Note F of Notes
to Consolidated Financial Statements.
(c) Operating profit for 1998 included income from receipt of $21.3 million from
an operator in the Bob West Field, representing funds that were no longer
needed as a contingency reserve for litigation.
(d) Includes effect of the Company's natural gas commodity price agreements
which amounted to a gain of $0.04 per Mcf in 1998 and to losses of $0.05 per
Mcf in 1997 and $0.11 per Mcf in 1996.
EXPLORATION AND PRODUCTION -- U.S.
1998 Compared with 1997. Segment operating profit from the Company's U.S.
exploration and production operations was $17.5 million, compared with $37.3
million in 1997. Comparability between these years was impacted by certain
significant items. Results for 1998 included income from receipt of $21.3
million from an operator in the Bob West Field, representing funds that were no
longer needed as a contingency reserve for litigation, and a write-down of its
domestic oil and gas properties of $28.4 million. In 1997, the Company
recognized income of $1.8 million for retroactive severance tax refunds.
Excluding these significant items, segment operating profit decreased by $10.9
million in 1998 primarily due to lower prices, higher depletion and increased
production costs.
Gross operating revenues from the Company's U.S. operations decreased by
$2.1 million as lower sale prices generally offset higher production volumes.
Prices realized by the Company on its natural gas production declined to $2.02
per Mcf in 1998 from $2.17 per Mcf in 1997. The Company's U.S. production
averaged 92.4 MMcfe per day in 1998, compared with 86.8 MMcfe per day in 1997.
The 5.6 MMcfe per day increase consisted of a 30.3 MMcfe per day increase in
production from outside the Bob West Field, partially offset by a 24.7 MMcfe per
day decline at the Bob West Field. Production from outside the Bob West Field
provided 55% of the Company's total production in 1998, compared to 24% in 1997.
Total production costs increased $2.3 million, to $9.7 million in 1998 from
$7.4 million in 1997. On a per unit basis, total production costs increased to
$0.29 per Mcfe in 1998 from $0.23 per Mcfe in 1997. Production costs from
outside the Bob West Field increased by $3.0 million due to the higher volumes
from these newer fields, but on a per unit basis, production costs from these
fields declined to $0.32 per Mcfe in 1998 from $0.40 per Mcfe in 1997.
Production costs at the Bob West Field decreased by $0.7 million due to the
decline in volumes which resulted in an increase in the per unit cost to $0.25
per Mcfe in 1998 from $0.18 per Mcfe in 1997.
Depreciation, depletion and amortization increased by $6.1 million, or 20%,
due to a higher depletion rate and increased production volumes. The higher
depletion rate of $1.04 per Mcfe in 1998, compared to $0.93 per Mcfe in 1997,
was due, in part, to the Company's emphasis on exploration, which accounted for
more than half of the total drilling costs in 1998. The Company's $28.4 million
write-down of capitalized costs of oil and gas properties, which was required by
the cost ceiling limitation under full-cost accounting, was primarily the result
of declines in oil and gas prices during the fourth quarter of 1998. Although
the effect of the write-down resulted in a noncash charge to operating profit in
1998, it will positively impact future earnings through lower depletion rates,
beginning in the first quarter of 1999. The 1998 year-end write-down reduced
amortizable domestic costs by 14%. It is reasonably possible that further
decreases in oil and natural gas prices since 1998 year-end may cause the
Company to reduce its capitalized costs of oil and gas properties in the near
term.
For information related to natural gas commodity price agreements, see
disclosures about market risk on page A-23 contained herein.
A-13
<PAGE> 40
1997 Compared with 1996. Segment operating profit from the Company's U.S.
exploration and production operations was $37.3 million in 1997, compared with
$123.9 million in 1996. Comparability between these years was impacted by
several major transactions in 1996, including the favorable resolution in August
1996 of litigation regarding the Tennessee Gas contract and the termination of
the remainder of the contract effective October 1, 1996. As provided for in the
Tennessee Gas contract, which was to expire in January 1999, the Company was
selling a portion of the gas produced in the Bob West Field pursuant to a
contract price, which was above the average spot market price. In total, during
1996, the Company received approximately $120 million in cash for the resolution
of litigation and termination of the Tennessee Gas contract, with the Company's
Exploration and Production segment recording other income of $60 million upon
termination of the contract. In 1996, the Exploration and Production segment's
operating profit also included $24.6 million from the excess of Tennessee Gas
contract prices over spot market prices. See Notes E and F of Notes to
Consolidated Financial Statements.
Additionally, during 1996, substantially all of the Company's proved
producing reserves in the Bob West Field were certified by the Texas Railroad
Commission as high-cost gas from a designated tight formation, eligible for
state severance tax exemptions from the date of first production through August
2001. Accordingly, no severance tax is recorded on current production from the
exempt wells in the Bob West Field beginning in 1996. In 1997 and 1996, the
Company recognized income of $1.8 million and $5.0 million, respectively, for
retroactive severance tax refunds for production in prior years.
Excluding the impact of the incremental contract value and income from the
severance tax refunds, segment operating profit from the Company's U.S.
operations would have been $35.5 million in 1997 compared with $34.3 million in
1996. The resulting increase of $1.2 million was primarily attributable to
higher spot market prices for natural gas sales, partially offset by higher
depletion and operating expenses.
Prices realized by the Company on its natural gas production sold in the
spot market increased 11% to $2.17 per Mcf in 1997 from $1.95 per Mcf in 1996.
The Company's weighted average sales price, which includes the above-market
pricing of the Tennessee Gas contract in 1996, decreased in 1997 due to the
termination of the contract. The Company's net production averaged 86.8 MMcfe
per day in 1997, a decrease of 0.9 MMcfe per day from 1996. This decrease
consisted of a 16.1 MMcfe per day decline from the Bob West Field, largely
offset by a 15.2 MMcfe per day increase from other U.S. fields.
Gross operating revenues from the Company's U.S. operations, after
excluding amounts related to Tennessee Gas, increased due to the higher spot
market prices. Production costs were higher by $2.1 million ($0.06 per Mcfe)
mainly due to costs at the Bob West Field. Administrative support and other
operating expenses decreased by $1.5 million. Depreciation and depletion
increased by $4.2 million, or 16%, due to a higher depletion rate.
EXPLORATION AND PRODUCTION -- BOLIVIA
1998 Compared with 1997. Segment operating results for the Company's
Bolivian operations decreased to a loss of $36.5 million, compared to operating
profit of $8.6 million in 1997. Results for 1998 included a $39.9 million
write-down of the Bolivian oil and gas properties, while results for 1997
included $2.2 million of income related to the collection of a receivable for
production in prior years. Excluding the write-down in 1998 and other income in
1997, segment operating profit for 1998 would have been $3.4 million compared to
$6.4 million in 1997. The decrease of $3.0 million in segment operating profit
was primarily due to the decline in Bolivian natural gas prices, which are
contractually indexed to posted New York fuel oil prices. Natural gas prices
fell 30% to $0.81 per Mcf in 1998 from $1.15 per Mcf in 1997. Condensate prices
also fell to $12.80 per barrel in 1998 from $15.71 per barrel in 1997. Net
production volumes, however, increased to 28.6 MMcfe per day from 22.6 MMcfe per
day. The Company's share of net production increased in 1998 as a result of the
July 1997 buyout of interests held by its former joint venture participant, and
the remaining production difference resulted in part from production constraints
in 1997 arising from repairs to a third-party pipeline that transports gas from
Bolivia to Argentina.
The increase in depreciation, depletion and amortization was due to the
higher production volumes and a higher depletion rate. The Company's $39.9
million write-down of capitalized costs of oil and gas properties,
A-14
<PAGE> 41
which was required by the cost ceiling limitation under full-cost accounting,
was primarily the result of declines in oil and gas prices during the fourth
quarter of 1998. Although the effect of the write-down resulted in a noncash
charge to operating profit in 1998, it will positively impact future earnings
through lower depletion rates, beginning in the first quarter of 1999. The 1998
year-end write-down reduced amortizable Bolivian costs by 28%. It is reasonably
possible that further decreases in oil and natural gas prices since 1998
year-end may cause the Company to reduce its capitalized costs of oil and gas
properties in the near term.
1997 Compared with 1996. Segment operating profit from the Company's
Bolivian operations decreased to $8.6 million in 1997 from $8.8 million in 1996.
Results for 1997 benefited from income of $2.2 million related to the collection
of a receivable for prior years' production. Without this income, segment
operating profit would have decreased by $2.4 million in 1997 due to declines in
natural gas and condensate production and prices. With the Company's purchase of
interests held by its former joint venture participant in July 1997, the
Company's share of production from Bolivia increased by approximately 33%
beginning in the 1997 third quarter (see Note C of Notes to Consolidated
Financial Statements). However, early in 1997, the Company's Bolivian natural
gas production was lower due to a reduction in minimum takes under the contract
between Yacimientos Petroliferos Fiscales ("YPFB") and Yacimientos Petroliferos
Fiscales ("YPF") and also due to constraints arising from repairs to a
third-party pipeline that transports gas from Bolivia to Argentina. In addition,
during 1996, production was higher due to requests from YPFB for additional
production from the Company to meet export specifications. Natural gas prices
fell 14% to $1.15 per Mcf in 1997, compared with $1.33 per Mcf in 1996.
Condensate prices fell 13% to $15.71 per barrel in 1997, compared to $17.98 per
barrel in 1996.
Other Factors. The Company's Bolivia natural gas is currently sold to YPFB,
a Bolivian government agency, which in turn sells the natural gas to YPF, a
publicly-held company based in Argentina. Currently, the Company's sale of
natural gas production is based on the volume and pricing terms in a take-or-pay
contract ("Argentina Contract") between YPFB and YPF. The Argentina Contract's
primary term ends March 31, 1999, and has been extended an additional five
months to August 31, 1999. The Company's share of the minimum contract volumes
from the Argentina Contract are 37 MMcf per day gross (26 net) through March 31,
1999 and 12 MMcf per day gross (9 net) from April 1999 through August 1999.
A lack of market access has constrained natural gas production in Bolivia.
Management believes that a third-party, 1,900-mile pipeline from Bolivia to
Brazil, which is expected to begin operations during the second quarter of 1999,
will provide access to potentially larger gas-consuming markets. Pipeline sales
will be governed by a 20-year take-or-pay contract ("Brazil Contract") between
YPFB and Petroleo Brasileiro, S.A. ("Petrobras"). Initial Brazilian demand
estimates are approximately 125 MMcf per day and are expected to increase to the
200 MMcf per day level by the end of 1999. Tesoro has a preferential right to
22% of the first 200 MMcf per day sold under the Brazil Contract. For
incremental demand above 200 MMcf per day, Petrobras, in its capacity as a
producer, has a preferential right to sell production from its Bolivian wells.
During March 1999, Petrobras exercised its preferential right for 23% of the
first increment of 123 MMcf per day of gas to be sold beginning in 2000 and for
100% of the second increment of 105 MMcf per day of gas to be sold beginning in
2001. Excluding Petrobras' preferential right for gas volumes in excess of 200
MMcf per day, remaining gas sales will be allocated by YPFB to the other
producers according to a number of factors, including each producer's reserve
volumes and production capacity. Although the new Bolivia-to-Brazil pipeline
creates the potential for increased Tesoro gas sales, Tesoro cannot be assured
that it will be able to maintain its approximate 20% historical market share for
gas sold in excess of 200 MMcf per day.
In Bolivia, the Company's reserves are classified by the government as
either existing or new hydrocarbons depending upon whether they were in
production prior to May 1, 1996 ("Existing Hydrocarbons") or after that date
("New Hydrocarbons"). Existing Hydrocarbons are subject to a 29% royalty to
YPFB, plus Bolivian taxes that are equal to an additional 31% of gross revenues.
New Hydrocarbons are subject to a more favorable tax treatment. New Hydrocarbons
are subject to a tax equal to 18% of gross revenues plus 25% of net income, and
there is no royalty paid to YPFB. Under certain circumstances, New Hydrocarbons
may be subject to additional taxes. During 1998, the Company paid taxes of $5.2
million to the Bolivian government which are netted against the income tax
benefit in the Consolidated Statements of Operations hereof.
A-15
<PAGE> 42
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $19.7 million in 1998, compared
with $13.6 million in 1997 and $12.7 million in 1996. The $6.1 million increase
in 1998 was primarily due to higher employee costs and professional fees partly
due to the design and implementation of an integrated enterprise-wide software
system. System design and implementation will continue in phases until all
system modules are implemented by the fourth quarter of 1999. When comparing
1997 to 1996, the increase was primarily due to higher employee costs, partially
offset by lower professional fees and insurance costs.
INTEREST AND FINANCING COSTS
Interest and financing costs totaled $33.0 million in 1998, compared with
$8.3 million in 1997 and $18.2 million in 1996. The $24.7 million increase in
1998 was primarily due to higher borrowings under the Company's credit
arrangements, including the new Senior Credit Facility, and the issuance of debt
securities which were used to fund the Acquisitions and the Refinancing and to
fund working capital requirements and capital expenditures (see Note D of Notes
to Consolidated Financial Statements). When comparing 1997 with 1996, the $9.9
million decrease in interest and financing costs reflected the interest savings
from redemption of $74 million in debt during November 1996.
INTEREST INCOME
Interest income was $2.0 million in 1998, compared with $1.6 million in
1997 and $8.4 million in 1996. In 1996, interest income included approximately
$7 million received from Tennessee Gas in conjunction with the collection of a
receivable which resulted from underpayment for natural gas sold in prior
periods (see Note F of Notes to Consolidated Financial Statements).
OTHER OPERATING COSTS AND OTHER EXPENSES
Other expense totaled $24.1 million in 1998, compared with $3.3 million in
1997 and $7.2 million in 1996. In 1998, the Company incurred a charge for
special incentive compensation which was earned in the second quarter when the
market price of the Company's Common Stock achieved a specific performance
target. This charge totaled $19.9 million, of which $7.9 million related to
operating segment employees. There were no material comparable charges recorded
in 1997. When comparing 1997 to 1996, the decrease in other expense was due to
costs incurred in 1996 of $2.3 million to resolve a shareholder consent
solicitation, together with a write-off of deferred financing costs and expenses
related to former operations. See Note F of Notes to Consolidated Financial
Statements.
INCOME TAX PROVISION
The Company recorded an income tax benefit of $0.5 million in 1998,
compared with income tax provisions of $18.4 million in 1997 and $38.3 million
in 1996. The income tax benefit in 1998 was due to the Company's loss in 1998,
but was largely offset by Bolivian taxes. When comparing 1997 to 1996, the
income tax provision decreased due to lower earnings, partially offset by
Bolivian taxes. See "Results of Operations -- Exploration and
Production -- Bolivia."
CAPITAL RESOURCES AND LIQUIDITY
OVERVIEW
The Company's primary sources of liquidity are its cash flows from
operations and borrowing availability under a revolving line of credit. Capital
requirements are expected to include capital expenditures, working capital, debt
service and preferred dividend requirements. Based upon current and anticipated
needs, management believes that available capital resources will be adequate to
meet anticipated future capital requirements.
A-16
<PAGE> 43
The Company operates in an environment where its liquidity and capital
resources are impacted by changes in price, supply and demand for crude oil,
natural gas and refined petroleum products, market uncertainty and a variety of
additional risks that are beyond the control of the Company. These risks
include, among others, the level of consumer product demand, weather conditions,
the proximity of the Company's natural gas reserves to pipelines, the capacities
of such pipelines, fluctuations in seasonal demand, governmental regulations,
the price and availability of alternative fuels and overall market and economic
conditions. The Company's future capital expenditures, as well as borrowings
under its credit arrangements and other sources of capital, will be affected by
these conditions.
CAPITALIZATION
During 1998, the Company invested $536 million in the Acquisitions and
spent an additional $185 million on natural gas property additions and other
capital projects. These investing activities, together with the Refinancing,
were funded with net proceeds of $533 million from equity and debt offerings,
cash flows from operations of $116 million and borrowings under term loans and
revolving credit lines. At December 31, 1998, the Company's total debt to
capitalization ratio was 49%.
Major changes in the Company's capitalization during 1998 were as follows:
- The issuance of 10,350,000 Premium Income Equity Securities ("PIES"),
representing fractional interests in the Company's 7.25% Mandatorily
Convertible Preferred Stock ("Preferred Stock"), provided the Company
with gross proceeds of $165 million. Holders of PIES are entitled to
receive a cash dividend. The PIES will automatically convert into shares
of Common Stock on July 1, 2001, at a rate based upon a formula dependent
upon the market price of Common Stock at the time of conversion. Before
July 1, 2001, each PIES is convertible, at the option of the holder
thereof, into 0.8455 shares of Common Stock, subject to adjustment in
certain events.
- The issuance of 5,750,000 shares of Common Stock provided the Company
with gross proceeds of $92 million.
- The issuance of $300 million aggregate principal amount of Senior
Subordinated Notes ("Senior Subordinated Notes") provided the Company
with $287 million of net proceeds. The Senior Subordinated Notes mature
in 2008, without sinking fund requirements, and are subject to optional
redemption by the Company after five years at declining premiums. The
indenture for the Senior Subordinated Notes contains covenants and
restrictions which are customary for notes of this nature. These
covenants and restrictions are less restrictive than those under the
Senior Credit Facility, discussed below.
- Substantially all of the Company's existing indebtedness at May 29, 1998,
including an obligation to the State of Alaska and loans which were used
to improve the Alaska Refinery, were refinanced in 1998.
- The Company entered into a $500 million Senior Credit Facility, comprised
of term loans aggregating $200 million and a revolving credit and letter
of credit facility aggregating $300 million, which bear interest at
variable rates. This facility replaced an interim credit facility which
was entered into in May 1998 to complete the Hawaii Acquisition and the
Refinancing, to pay related fees and expenses and for general corporate
purposes. The interim credit facility replaced the Company's previous
corporate revolving credit agreement. For further information on the
Senior Credit Facility, see "Credit Arrangements" discussed below.
- As part of the Hawaii Acquisition, the Company issued an unsecured,
non-interest bearing promissory note ("BHP Note") in the amount of $50
million, payable in five equal annual installments of $10 million each,
beginning 2009. The BHP Note provides for early payments based upon
achievement of a specified level of cash flows from the acquired assets.
The Senior Credit Facility, Senior Subordinated Notes and PIES impose
various restrictions and covenants on the Company that could potentially limit
the Company's ability to respond to market conditions,
A-17
<PAGE> 44
to provide for anticipated capital investments, to raise additional debt or
equity capital or to take advantage of business opportunities.
For further information on the Company's capital structure, see Note D of
Notes to Consolidated Financial Statements.
CREDIT ARRANGEMENTS
During July 1998, the Company entered into the Senior Credit Facility,
comprised of term loans aggregating $200 million ("Term Loans") and a revolving
credit and letter of credit facility aggregating $300 million ("Revolver"). The
Senior Credit Facility is guaranteed by substantially all of the Company's
active direct and indirect subsidiaries ("Guarantors") and is secured by
substantially all of the domestic assets of the Company and each of the
Guarantors. At December 31, 1998, the Company had outstanding borrowings of
$149.5 million under the Term Loans and $61.2 million under the Revolver.
Outstanding letters of credit totaled $14 million at 1998 year-end. Unused
availability under the Senior Credit Facility and Term Loans was approximately
$275 million at December 31, 1998. On January 4, 1999, the final $50 million
tranche under the Term Loans was borrowed and used to reduce outstanding
borrowings under the Revolver. The Revolver terminates in July 2001, while the
Term Loans mature over varying periods through the end of 2003.
The Senior Credit Facility requires the Company to maintain specified
levels of consolidated leverage and interest coverage and contains other
covenants and restrictions customary in credit arrangements of this kind. The
Company was in compliance with these covenants at December 31, 1998. Future
compliance with financial covenants under the Senior Credit Facility is
primarily dependent on the Company's cash flows and levels of borrowings under
the Revolver. Based on market conditions in the first quarter of 1999, including
depressed natural gas prices and downturn in refinery margins, continued
compliance with such covenants is not assured. If the Company is not able to
continue to comply with its financial covenants, it will be required to seek
waivers or amendments from its lenders. If such an event occurs, management of
the Company believes that it will be able to obtain waivers and/or negotiate
terms and conditions with its lenders under the Senior Credit Facility which
will allow the Company to adequately finance its operations.
The terms of the Senior Credit Facility allow for payment of cash dividends
on the Company's Common Stock not to exceed an aggregate of $10 million in any
year and also allow for payment of required dividends on its Preferred Stock.
The Board of Directors has no present plans to pay dividends on Common Stock.
However, from time to time the Board of Directors reevaluates the feasibility of
declaring future dividends.
Provisions of the Senior Credit Facility require prepayments to the Term
Loans, with certain defined exceptions, in an amount equal to: (i) 100% of the
net proceeds of certain incurred indebtedness; (ii) 100% of the net proceeds
received by the Company and its subsidiaries (other than certain net proceeds
reinvested in the business of the Company or its subsidiaries) from the
disposition of any assets, including proceeds from the sale of stock of the
Company's subsidiaries; and (iii) a percentage of excess cash flow, as defined,
depending on certain credit statistics. No prepayments were required for 1998.
For further information concerning debt maturities and restrictions and
covenants, see Note D of Notes to Consolidated Financial Statements.
CAPITAL SPENDING (EXCLUDING AMOUNTS TO FUND DOWNSTREAM ACQUISITIONS)
Capital spending in 1998 totaled $185 million which was funded from
internally-generated cash flows from operations and external financing. Capital
expenditures for the Exploration and Production segment were approximately $135
million, including $87 million for U.S. operations and $48 million for Bolivia
operations. In the U.S., capital expenditures were principally for participation
in the drilling of 26 development wells (23 completed), 19 exploratory wells (11
completed), the purchase of 28 billion cubic feet equivalent of proved reserves
and 56,000 net leased acres and seismic activity. In Bolivia, capital projects
included the drilling of three exploration wells (all successful), the
construction of gathering lines and seismic activity. Capital projects for the
Refining and Marketing segment in 1998 totaled $38 million, which included costs
of a
A-18
<PAGE> 45
long-term capital program to improve marketing operations, upgrades to the
refineries and environmental projects. In the Marine Services segment, capital
spending totaled $4 million during 1998, primarily for equipment and facilities
upgrades. Capital expenditures of $8 million for corporate projects in 1998 were
primarily directed towards the design and implementation of an integrated
enterprise-wide software system, which is expected to be completed in the fourth
quarter of 1999. An additional $12 million is expected to be spent on this
system project in 1999.
For 1999, the Company has a capital budget program totaling $170 million.
The Exploration and Production segment accounts for $75 million, or 44%, of the
budget with $50 million planned for U.S. activities and $25 million for Bolivia.
In the U.S., the Company will focus on exploration of undeveloped acreage using
3-D seismic data to increase its proved reserves. Thirty exploration wells and
15 development wells are budgeted for drilling in 1999. Other capital
investments include geophysical studies that may lead to additional discoveries
in the U.S. In Bolivia, the Company does not plan any additional drilling in
Bolivia during 1999 beyond one well in progress, and is directing the majority
of its capital program toward improving its gas processing facilities to enable
the Company to process higher production volumes expected to result when the
new, third-party Bolivia-to-Brazil pipeline begins operations expected in the
second quarter of 1999. Capital spending for the Refining and Marketing segment
is planned at $68 million, which includes $34 million for refining and
distribution projects, $19 million for retail marketing operations and $15
million for environmental and safety. The Marine Services capital budget is $7
million and is primarily directed towards facility and terminal improvements.
Corporate capital improvements are planned for $20 million in 1999, which
include the remaining costs of the integrated enterprise-wide system as well as
costs for other corporate projects. Actual capital expenditures for 1999 are
expected to be financed primarily from operating cash flows. Actual capital
expenditures may vary from these projections due to a number of factors,
including the timing of projects which could be impacted by the ability of the
Company to generate cash flows in depressed industry conditions.
CASH FLOW SUMMARY
Components of the Company's cash flows are set forth below (in millions):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- ------
<S> <C> <C> <C>
Cash Flows From (Used In):
Operating Activities...................................... $ 116.5 $ 95.6 $178.9
Investing Activities...................................... (718.6) (151.5) (94.2)
Financing Activities...................................... 606.6 41.5 (75.9)
------- ------- ------
Increase (Decrease) in Cash and Cash Equivalents............ $ 4.5 $ (14.4) $ 8.8
======= ======= ======
</TABLE>
During 1998, net cash from operating activities totaled $116 million,
compared with $96 million in 1997. Operating cash flows in 1998 included higher
levels of earnings before noncash charges, including depreciation, depletion and
amortization and write-downs of oil and gas properties. The Company's results in
1998 included income from receipt of $21 million pretax ($14 million aftertax)
from an operator in the Bob West Field (see Note F of Notes to Consolidated
Financial Statements). In addition, changes in working capital components
contributed positively to cash flows from operations in 1998. Net cash used in
investing activities of $719 million in 1998 included $536 million for the
Acquisitions and $185 million for capital expenditures. Net cash from financing
activities of $607 million in 1998 primarily included net proceeds of $533
million from the issuance of equity and debt securities and $150 million from
Term Loans, partially offset by net repayments of other debt. Gross borrowings
under revolving credit lines and interim credit facility amounted to $944
million, while repayments totaled $916 million. Payments of dividends on
preferred stock totaled $3 million in 1998. At December 31, 1998, the Company's
working capital totaled $182 million, including cash and cash equivalents of $13
million, compared with working capital of $74 million at year-end 1997. The
working capital ratio at December 31, 1998 improved to 1.9:1, compared with
1.7:1 at the end of 1997.
A-19
<PAGE> 46
During 1997, net cash from operating activities totaled $96 million, which
included $77 million from earnings before depreciation, depletion and
amortization and $7 million from favorable working capital changes. Net cash
used in investing activities of $151 million in 1997 included capital
expenditures of $93 million for exploration and production activities, $44
million for refining and marketing projects and $9 million for upgrades in
marine services. Net cash from financing activities of $41 million in 1997
included net borrowings of $28 million under the former credit facility and
receipt of $16 million under a loan for the hydrocracker expansion, partially
offset by payments of other long-term debt and repurchases of Common Stock.
During 1997, gross borrowings under the Company's former credit facility were
$150 million, with $122 million of repayments.
During 1996, net cash from operating activities totaled $179 million, which
included $120 million from Tennessee Gas for the favorable resolution of
litigation in August 1996 and termination of the natural gas purchase and sales
contract effective October 1, 1996. In addition, improved profitability
contributed to higher cash flows from operations. Partially offsetting these
increases were higher working capital balances, particularly receivables which
increased primarily due to higher year-end sales volumes together with higher
prices. In 1996, net cash used in investing activities of $94 million included
capital expenditures of $85 million and cash consideration of nearly $8 million
for a marine services acquisition. Net cash used in financing activities of $76
million was primarily due to the redemption of debt aggregating $74 million
together with payments of other long-term debt. During 1996, the Company's gross
borrowings and repayments under its corporate revolving credit line amounted to
$165 million.
ENVIRONMENTAL
The Company is subject to extensive federal, state and local environmental
laws and regulations. These laws, which change frequently, regulate the
discharge of materials into the environment and may require the Company to
remove or mitigate the environmental effects of the disposal or release of
petroleum or chemical substances at various sites or install additional controls
or other modifications or changes in use for certain emission sources. The
Company is currently involved in remedial responses and has incurred cleanup
expenditures associated with environmental matters at a number of sites,
including certain of its own properties. At December 31, 1998, the Company's
accruals for environmental expenses amounted to $9.3 million. Based on currently
available information, including the participation of other parties or former
owners in remediation actions, the Company believes these accruals are adequate.
To comply with environmental laws and regulations, the Company anticipates that
it will make capital improvements of approximately $12 million in 1999 and $5
million in 2000. In addition, capital expenditures for alternative secondary
containment systems for existing storage tank facilities are estimated to be $2
million in 1999 and $1 million in 2000 with a remaining $4 million expected to
be spent by 2002.
Conditions that require additional expenditures may exist for various
Company sites, including, but not limited to, the Company's refineries, retail
gasoline stations (operating and closed locations) and petroleum product
terminals, and for compliance with the Clean Air Act and other state and federal
regulations. The amount of such future expenditures cannot currently be
determined by the Company. For further information on environmental
contingencies, see Note M of Notes to Consolidated Financial Statements.
YEAR 2000 READINESS DISCLOSURE
The efficient operation of the Company's business is dependent on its
computer hardware, operating systems and software programs (collectively,
"Systems and Programs"). These Systems and Programs are used in several key
areas of the Company's business, including production and distribution,
information management services and financial reporting, as well as in various
administrative functions. The goal of the Company's Year 2000 project is to
prevent any disruption to the Company's business processes or its ability to
conduct business resulting from Year 2000 computer issues.
The Year 2000 may cause problems in systems that use dates. Many systems
such as computers, computer applications, process equipment used in refineries,
phone systems, and electrical components have embedded chips that are subject to
failure. Failures result from the practice of representing the year as a
A-20
<PAGE> 47
2-digit number, and then treating "00" as the year 1900, not 2000. Other
failures may result if the Year 2000 is not recognized as a leap year.
Disruptions may also be caused by computer failures of external sources such as
vendors, service providers and customers.
To identify and eliminate potential disruptions, the Company developed a
Year 2000 compliance plan ("Compliance Plan") with respect to those Systems and
Programs that are deemed to be critical to the Company's operations and safety.
The Compliance Plan, which covers information technology ("IT") and non-IT
aspects, is divided into the following sections: Plant Facilities (includes
non-IT embedded systems such as process control systems, environmental systems
and the physical equipment and facilities at the Company's exploration and
production locations, refineries and transportation vessels), Business Systems
(includes IT hardware, software, and network systems serving the Company's
business units), Office Facilities (includes telephone, security, and office
equipment) and External Sources (customers, suppliers and vendors).
Implementation of the Compliance Plan is led by an oversight committee,
made up of representatives from each of the Company's major facilities. The
Compliance Plan is monitored weekly and progress is reported to management and
the Board of Directors.
The Compliance Plan includes the following phases and scheduled completion
dates:
<TABLE>
<CAPTION>
SCHEDULED
% COMPLETE COMPLETION DATE
---------- ---------------
<S> <C> <C> <C>
- - Awareness: Establish a Year 2000 team and develop a detailed
plan...................................................... 100 Complete
- - Assessment: Identify critical business processes and systems
that must be modified; assess and prioritize risk
factors................................................... 100 Complete
- - Remediation: Convert, replace or eliminate hardware and
software.................................................. 80 July 1999
- - Validation: Test and verify................................. 75 July 1999
- - Implementation: Put new and renovated systems into
production; monitor and continually evaluate.............. 60 July 1999
- - Contingency Plans: Develop contingency plans for critical
items that cannot be tested............................... 10 September 1999
</TABLE>
The Company has utilized both internal and external resources in evaluating
its Systems and Programs, as well as manual processes, external interfaces with
customers and services supplied by vendors, to identify potential Year 2000
compliance problems. The Company has identified and is replacing a number of
Systems and Programs that are not Year 2000 compliant. Based on current
information, the Company expects to attain Year 2000 compliance and complete
appropriate testing of its modifications and replacements in advance of the Year
2000 date change. Modification or replacement of the Company's Systems and
Programs is being performed in-house by Company personnel and external
consultants.
The Company believes that, with hardware replacement and modifications to
existing software or conversions to new software, the Year 2000 date change will
not pose a significant operational problem for the Company. However, because
most computer systems are, by their very nature, interdependent, it is possible
that non-compliant third-party computer systems or programs may not interface
properly with the Company's computer systems.
The Company has requested assurance from third parties that their
computers, systems or programs be Year 2000 compliant. Approximately 3,000
questionnaires were sent to vendors who were identified as providing goods and
services to the Company's operations. Vendors were asked questions relating to
their Year 2000 preparation and readiness. Over half of the vendors either
returned the questionnaire or were contacted and interviewed personally. Of
those contacted, none could foresee that they would have a problem with the
delivery of goods or services on or after January 1, 2000. Efforts will continue
to contact the remaining critical vendors by June 1999. The utility companies
providing electricity and water to the Company's various locations were
contacted and questioned about their ability to provide uninterrupted service
and have all responded positively.
A-21
<PAGE> 48
The Company is in the process of contacting 500 key customers to determine
their Year 2000 preparation and readiness. This effort is expected to be
completed by June 1999. Although the effort of contacting key customers and
vendors is not complete, management believes that the Company's risk is minimal
as it relates to key vendors and suppliers.
The Company expects that expenses and capital expenditures associated with
the Year 2000 compliance project will not have a material effect on its
business, financial condition or results of operations. The Company spent
approximately $1 million in 1998 and expects to spend $4 million in 1999 to
become Year 2000 compliant. The costs of Year 2000 compliance are the best
estimates of the Company's management and are believed to be reasonably
accurate. In the event the Compliance Plan is not successfully or timely
implemented, the Company may need to devote more resources to the process and
additional costs may be incurred. The costs of implementing the integrated
enterprise-wide system are excluded as this system implementation was undertaken
primarily to improve business processes.
If the Company were not able to satisfactorily complete its Compliance
Plan, including identifying and resolving problems encountered by the Company's
external service providers, potential consequences could include, among other
things, unit downtime at, or damage to, the Company's refineries, gas stations,
terminal facilities and pipelines; delays in transporting refinery feedstocks
and refined products; reduction in natural gas production; impairment of
relationships with significant suppliers or customers; loss of accounting data
or delays in processing such data; and loss of or delays in internal and
external communications. The occurrence of any or all of the above could result
in a material adverse effect on the Company's results of operations, liquidity
or financial condition. Although the Company currently believes that it will
satisfactorily complete its Compliance Plan prior to January 1, 2000, there can
be no assurance that it will be completed by such time or that the Year 2000
problem will not adversely affect the Company and its business.
The foregoing statements in the above paragraphs under "Year 2000 Readiness
Disclosure" herein are intended to be and are hereby designated "Year 2000
Readiness Disclosure" statements within the meaning of the Year 2000 Information
and Readiness Disclosure Act.
NEW ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities. SFAS No. 133 requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. The
accounting for changes in the fair value of a derivative depends on the intended
use of the derivative and the resulting designation. SFAS No. 133 is effective
for all quarters of fiscal years beginning after June 15, 1999 and should not be
applied retroactively to financial statements of prior periods. From time to
time, the Company enters into agreements to reduce commodity price risks. Gains
or losses on these hedging activities are recognized when the related physical
transactions are recognized as sales or purchases. The Company is evaluating the
effects that this new statement will have on its financial condition, results of
operations and financial reporting and disclosures.
FORWARD-LOOKING STATEMENTS
This Appendix A to the Proxy Statement for the 1999 Annual Meeting of
Stockholders contains certain statements that are "forward-looking" statements
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act") and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). These forward-looking statements include, among
other things, discussions of anticipated revenue enhancements and cost savings
following the Acquisitions, the Company's business strategy and expectations
concerning the Company's market position, future operations, margins,
profitability, liquidity and capital resources, expenditures for capital
projects and attempts to reduce costs. Although the Company believes that the
assumptions upon which the forward-looking statements contained in this Appendix
A are based are reasonable, any of the assumptions could prove to be inaccurate
and, as a result, the
A-22
<PAGE> 49
forward-looking statements based on those assumptions also could be incorrect.
All phases of the operations of the Company involve risks and uncertainties,
many of which are outside the control of the Company and any one of which, or a
combination of which, could materially affect the results of the Company's
operations and whether the forward-looking statements ultimately prove to be
correct. Actual results and trends in the future may differ materially depending
on a variety of factors including, but not limited to, the timing and extent of
changes in commodity prices and underlying demand and availability of crude oil
and other refinery feedstocks, refined products, and natural gas; changes in the
cost or availability of third-party vessels, pipelines and other means of
transporting feedstocks and products; execution of planned capital projects;
adverse changes in the credit ratings assigned to the Company's trade credit;
future well performance; the extent of the Company's success in acquiring oil
and gas properties and in discovering, developing and producing reserves; state
and federal environmental, economic, safety and other policies and regulations,
any changes therein, and any legal or regulatory delays or other factors beyond
the Company's control; adverse rulings, judgments, or settlements in litigation
or other legal matters, including unexpected environmental remediation costs in
excess of any reserves; actions of customers and competitors; weather conditions
affecting the Company's operations or the areas in which the Company's products
are marketed; earthquakes or other natural disasters affecting operations;
political developments in foreign countries; and the conditions of the capital
markets and equity markets during the periods covered by the forward-looking
statements. All subsequent written and oral forward-looking statements
attributable to the Company or persons acting on its behalf are expressly
qualified in their entirety by the foregoing. The Company undertakes no
obligation to publicly release the result of any revisions to any such
forward-looking statements that may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.
III. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company utilizes various financial instruments and enters into
agreements which inherently have some degree of market risk. The primary sources
of market risk include fluctuations in commodity prices and interest rate
fluctuations.
PRICE FLUCTUATIONS
The Company's refining and marketing earnings and cash flows from
operations are dependent upon the margin above fixed and variable expenses
(including the cost of crude oil feedstocks) at which the Company is able to
sell refined products. In recent years, the prices of crude oil and refined
products have fluctuated substantially. These prices depend on numerous factors,
including the demand for crude oil, gasoline and other refined products, which
in turn depend on, among other factors, changes in the economy, the level of
foreign and domestic production of crude oil and refined products, political
conditions in the Middle East, the availability of imports of crude oil and
refined products, the marketing of alternative and competing fuels and the
extent of government regulations. The prices received by the Company for its
refined products are also affected by local factors such as local market
conditions and the level of operations of other refineries in Alaska, Hawaii and
Washington.
The price at which the Company can sell its refined products will be
strongly influenced by the commodity price of crude oil. Generally, an increase
or decrease in the price of crude oil results in a corresponding increase or
decrease in the price of gasoline and other refined products and could have a
significant short-term impact on the Company's refining operations and the
earnings and cash flows of the Company as a whole. However, each of the
Company's refineries maintains inventories of crude oil, intermediate products
and refined products, the value of each of which is subject to rapid fluctuation
in market prices. In addition, crude oil supply contracts are generally
contracts with market-responsive pricing provisions.
Any significant decline in the price for natural gas could have a material
adverse effect on the Company's exploration and production operations and the
financial condition of the Company as a whole. Prices for natural gas are
subject to wide fluctuations in response to relatively minor changes in the
supply of and demand for natural gas, market uncertainty and a variety of
additional factors that are beyond the control of the Company. These factors
include the domestic and foreign supply of natural gas, the level of consumer
A-23
<PAGE> 50
demand, weather conditions, domestic and foreign government regulations, the
price and availability of alternative fuels and overall economic conditions.
While the Company from time to time enters into agreements with respect to a
portion of its future production in an effort to reduce price risk, including
commodity price contracts and forward sales agreements, there can be no
assurance that such transactions will reduce risk or mitigate the effect of any
substantial or prolonged decline in the price of natural gas. During 1998, 1997
and 1996, the Company used such agreements to set the price of 13%, 9% and 30%,
respectively, of the natural gas production that it sold in the spot market. In
1998, the Company recognized a gain of $1.3 million ($0.04 per Mcf) from these
price agreements. During 1997 and 1996, the effects of natural gas price
agreements resulted in losses of $1.6 million ($0.05 per Mcf) and $3.1 million
($0.11 per Mcf), respectively. As of year-end 1998, the Company had remaining
price agreements outstanding through March 31, 1999 for 500 MMcf of natural gas
production with an average Houston Ship Channel floor price of $2.15 per Mcf and
an average ceiling price of $2.59 per Mcf.
The volatility of prices and their effect on the Company's earnings and
cash flows are also discussed in "Business Environment" in Management's
Discussion and Analysis of Financial Condition and Results of Operations"
hereof.
INTEREST RATE RISK
Total debt at December 31, 1998 included $211 million of floating-rate debt
attributed to the Term Loans and the Revolver and $333 million of fixed-rate
debt. As a result, the Company's annual interest cost in 1999 will fluctuate
based on short-term interest rates. The impact on annual cash flows of a 10%
change in the floating rate (approximately 70 basis points) would be
approximately $1.5 million.
At December 31, 1998, the fair market value of the Company's fixed-rate
debt approximated its book value of $333 million. The floating-rate debt will
mature over varying periods through the end of 2003. Fixed-rate debt of $297
million will mature in 2008, while other fixed-rate notes and obligations will
mature over varying periods through 2013.
A-24
<PAGE> 51
IV. FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Tesoro Petroleum Corporation
We have audited the accompanying consolidated balance sheets of Tesoro
Petroleum Corporation and subsidiaries as of December 31, 1998 and 1997, and the
related statements of consolidated operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Tesoro Petroleum Corporation
and subsidiaries at December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
San Antonio, Texas
January 29, 1999
(March 25, 1999 as to Note M)
A-25
<PAGE> 52
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED OPERATIONS
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------ --------
<S> <C> <C> <C>
REVENUES
Refining and marketing.................................... $1,268.0 $720.9 $ 745.4
Marine services........................................... 118.6 132.2 122.5
Exploration and production................................ 82.0 84.8 107.5
Other income.............................................. 21.7 5.5 64.4
-------- ------ --------
Total Revenues.................................... 1,490.3 943.4 1,039.8
-------- ------ --------
OPERATING COSTS AND EXPENSES
Refining and marketing.................................... 1,172.6 687.1 726.1
Marine services........................................... 107.9 124.7 115.3
Exploration and production................................ 16.2 13.2 13.0
Depreciation, depletion and amortization.................. 66.0 45.7 40.6
Write-downs of oil and gas properties..................... 68.3 -- --
-------- ------ --------
Total Operating Costs and Expenses................ 1,431.0 870.7 895.0
-------- ------ --------
SEGMENT OPERATING PROFIT.................................... 59.3 72.7 144.8
Other operating costs and expenses.......................... (7.9) -- --
General and administrative.................................. (19.7) (13.6) (12.7)
Interest and financing costs, net of capitalized interest in
1998 and 1997............................................. (33.0) (8.3) (18.2)
Interest income............................................. 2.0 1.6 8.4
Other expense, net.......................................... (16.2) (3.3) (7.2)
-------- ------ --------
EARNINGS (LOSS) BEFORE INCOME TAXES AND EXTRAORDINARY
ITEM...................................................... (15.5) 49.1 115.1
Income tax provision (benefit).............................. (0.5) 18.4 38.3
-------- ------ --------
EARNINGS (LOSS) BEFORE EXTRAORDINARY ITEM................... (15.0) 30.7 76.8
Extraordinary loss on extinguishments of debt (net of income
tax benefit of $2.6 in 1998 and $0.9 in 1996)............. (4.4) -- (2.3)
-------- ------ --------
NET EARNINGS (LOSS)......................................... (19.4) 30.7 74.5
Preferred dividend requirements............................. (6.0) -- --
-------- ------ --------
NET EARNINGS (LOSS) APPLICABLE TO COMMON STOCK.............. $ (25.4) $ 30.7 $ 74.5
======== ====== ========
NET EARNINGS (LOSS) PER SHARE -- BASIC...................... $ (0.86) $ 1.16 $ 2.87
======== ====== ========
NET EARNINGS (LOSS) PER SHARE -- DILUTED.................... $ (0.86) $ 1.14 $ 2.81
======== ====== ========
WEIGHTED AVERAGE COMMON SHARES -- BASIC..................... 29.4 26.4 26.0
======== ====== ========
WEIGHTED AVERAGE COMMON SHARES AND POTENTIALLY DILUTIVE
COMMON SHARES -- DILUTED.................................. 29.4 26.9 26.5
======== ====== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-26
<PAGE> 53
TESORO PETROLEUM CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
-------- ------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................. $ 12.9 $ 8.4
Receivables, less allowance for doubtful accounts......... 157.5 76.3
Inventories............................................... 208.2 87.3
Prepayments and other..................................... 12.0 9.8
-------- ------
Total Current Assets................................. 390.6 181.8
-------- ------
PROPERTY, PLANT AND EQUIPMENT
Refining and marketing.................................... 841.0 370.2
Marine services........................................... 50.8 43.1
Exploration and production, full-cost method of
accounting:
Properties being amortized........................... 393.3 251.6
Properties not yet evaluated......................... 25.1 31.9
Gas transportation................................... 8.1 7.9
Corporate................................................. 21.4 13.6
-------- ------
1,339.7 718.3
Less accumulated depreciation, depletion and
amortization........................................... 445.1 304.5
-------- ------
Net Property, Plant and Equipment.................... 894.6 413.8
-------- ------
OTHER ASSETS................................................ 143.2 32.2
-------- ------
Total Assets...................................... $1,428.4 $627.8
======== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable.......................................... $ 126.4 $ 58.8
Accrued liabilities....................................... 69.3 31.7
Current maturities of long-term debt and other
obligations............................................ 12.5 17.0
-------- ------
Total Current Liabilities............................ 208.2 107.5
-------- ------
DEFERRED INCOME TAXES....................................... 69.9 28.8
-------- ------
OTHER LIABILITIES........................................... 59.7 43.2
-------- ------
LONG-TERM DEBT AND OTHER OBLIGATIONS, LESS CURRENT
MATURITIES................................................ 531.4 115.3
-------- ------
COMMITMENTS AND CONTINGENCIES (Note M)
STOCKHOLDERS' EQUITY
Preferred stock, no par value; authorized 5,000,000
shares:
7.25% Mandatorily Convertible Preferred Stock, 103,500
shares issued and outstanding in 1998.................. 165.0 --
Common stock, par value $0.16 2/3; authorized 100,000,000
shares (50,000,000 in 1997); 32,654,138 shares issued
(26,506,601 in 1997)................................... 5.4 4.4
Additional paid-in capital................................ 278.6 190.9
Retained earnings......................................... 115.6 141.0
Treasury stock, 320,022 common shares (216,453 in 1997),
at cost................................................ (5.4) (3.3)
-------- ------
Total Stockholders' Equity........................... 559.2 333.0
-------- ------
Total Liabilities and Stockholders' Equity........ $1,428.4 $627.8
======== ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-27
<PAGE> 54
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
(IN MILLIONS)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL TREASURY STOCK
--------------- --------------- PAID-IN RETAINED ---------------
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT
------ ------ ------ ------ ---------- -------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996.............. -- $ -- 24.8 $4.1 $176.6 $ 35.8 -- $ --
Net earnings.......................... -- -- -- -- -- 74.5 -- --
Issuance of Common Stock.............. -- -- 1.3 0.2 11.1 -- -- --
Other, primarily exercise of stock
options and awards................. -- -- 0.3 0.1 1.7 -- -- --
--- ------ ---- ---- ------ ------ ---- -----
BALANCE AT DECEMBER 31, 1996............ -- -- 26.4 4.4 189.4 110.3 -- --
Net earnings.......................... -- -- -- -- -- 30.7 -- --
Shares repurchased.................... -- -- -- -- -- -- (0.2) (3.7)
Other, primarily exercise of stock
options and awards................. -- -- 0.1 -- 1.5 -- -- 0.4
--- ------ ---- ---- ------ ------ ---- -----
BALANCE AT DECEMBER 31, 1997............ -- -- 26.5 4.4 190.9 141.0 (0.2) (3.3)
Net loss.............................. -- -- -- -- -- (19.4) -- --
Preferred dividend requirements....... -- -- -- -- -- (6.0) -- --
Issuance of Common Stock.............. -- -- 5.7 0.9 85.8 -- -- --
Issuance of Preferred Stock........... 0.1 165.0 -- -- (5.7) -- -- --
Other, primarily related to shares
issued under special incentive
strategy........................... -- -- 0.4 0.1 7.6 -- (0.1) (2.1)
--- ------ ---- ---- ------ ------ ---- -----
BALANCE AT DECEMBER 31, 1998............ 0.1 $165.0 32.6 $5.4 $278.6 $115.6 (0.3) $(5.4)
=== ====== ==== ==== ====== ====== ==== =====
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-28
<PAGE> 55
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997 1996
------- ------- ------
<S> <C> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net earnings (loss)....................................... $ (19.4) $ 30.7 $ 74.5
Adjustments to reconcile net earnings to net cash from
operating activities:
Depreciation, depletion and amortization............... 67.1 46.4 41.5
Write-downs of oil and gas properties.................. 68.3 -- --
Amortization of goodwill and deferred charges.......... 4.0 1.0 1.6
Extraordinary loss on extinguishments of debt, net of
income tax benefit................................... 4.4 -- 2.3
Other noncash charges, including noncash portion of
special incentive compensation and loss on sales of
assets............................................... 9.6 0.5 0.8
Changes in operating assets and liabilities:
Receivables.......................................... (31.0) 56.8 8.1
Inventories.......................................... 1.6 (11.5) 7.2
Other assets......................................... (13.7) 0.3 (3.5)
Accounts payable and accrued liabilities............. 39.4 (37.9) 28.1
Deferred income taxes................................ (11.4) 9.7 14.6
Obligation payments to State of Alaska............... (3.0) (4.4) (4.0)
Other liabilities and obligations.................... 0.6 4.0 7.7
------- ------- ------
Net cash from operating activities................ 116.5 95.6 178.9
------- ------- ------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures...................................... (185.1) (147.5) (85.0)
Acquisitions.............................................. (536.5) (5.1) (7.7)
Proceeds from sales of assets............................. 3.2 0.1 2.6
Other..................................................... (0.2) 1.0 (4.1)
------- ------- ------
Net cash used in investing activities............. (718.6) (151.5) (94.2)
------- ------- ------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Proceeds from equity offerings, net....................... 246.0 -- --
Proceeds from debt offerings, net......................... 286.7 -- --
Borrowings under term loans............................... 150.0 -- --
Refinancing and repayments of debt and obligations........ (93.3) (4.1) (77.9)
Borrowings under revolving credit and interim facilities,
net of repayments...................................... 27.6 32.7 0.9
Issuance of other long-term debt.......................... -- 16.2 --
Payment of dividends on Preferred Stock................... (3.0) -- --
Repurchase of Common Stock................................ -- (3.7) --
Financing costs and other................................. (7.4) 0.4 1.1
------- ------- ------
Net cash from (used in) financing activities...... 606.6 41.5 (75.9)
------- ------- ------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ 4.5 (14.4) 8.8
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 8.4 22.8 14.0
------- ------- ------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 12.9 $ 8.4 $ 22.8
======= ======= ======
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid, net of capitalized interest of $0.1 in 1998
and $0.4 in 1997....................................... $ 12.0 $ 2.1 $ 12.5
======= ======= ======
Income taxes paid......................................... $ 16.4 $ 22.4 $ 6.3
======= ======= ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-29
<PAGE> 56
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying Consolidated Financial Statements include the accounts of
Tesoro Petroleum Corporation and its subsidiaries (collectively, the "Company"
or "Tesoro"). All significant intercompany accounts and transactions have been
eliminated. Tesoro is a natural resource company engaged in petroleum refining,
distribution and marketing of petroleum products, marine logistics services and
the exploration for and production of natural gas and oil.
Use of Estimates and Presentation
Preparation of the Company's Consolidated Financial Statements in
conformity with generally accepted accounting principles requires the use of
management's best estimates and judgment that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the year. Actual results could differ from those estimates.
Certain reclassifications have been made to information previously reported
to conform to current presentation.
Cash and Cash Equivalents
Cash equivalents consist of highly-liquid debt instruments such as
commercial paper and certificates of deposit purchased with an original maturity
date of three months or less. Cash equivalents are stated at cost, which
approximates market value. The Company's policy is to invest cash in
conservative, highly-rated instruments and to invest in various institutions to
limit the amount of credit exposure in any one institution. The Company performs
ongoing evaluations of the credit standing of these financial institutions.
Financial Instruments
The carrying amounts of financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable and certain accrued
liabilities, approximate fair value because of the short maturity of these
instruments. The carrying amounts of the Company's long-term debt and other
obligations approximate the Company's estimates of the fair value of such items.
Inventories
Inventories are stated at the lower of cost or market. The last-in,
first-out ("LIFO") method is used to determine the cost of the Company's
refining and marketing inventories of crude oil and U.S. wholesale refined
products. The cost of remaining refined product inventories, including fuel at
the Company's marine services terminals, is determined principally on the
first-in, first-out ("FIFO") method. The carrying value of petroleum inventories
is sensitive to volatile market prices. Merchandise and materials and supplies
are valued at average cost, not in excess of market value. See Note I.
Property, Plant and Equipment
Additions to property, plant and equipment and major improvements and
modifications are capitalized at cost. Depletion of oil and gas producing
properties is determined principally by the unit-of-production method and is
based on estimated proved recoverable reserves. Depreciation of other property,
plant and equipment is generally computed on the straight-line method based upon
the estimated useful life of each asset. The weighted average lives range from 8
to 30 years for refining, marketing and pipeline assets, 13 to 15 years for
service equipment and marine fleets, and three to seven years for corporate and
other assets.
A-30
<PAGE> 57
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Oil and gas properties are accounted for using the full-cost method of
accounting. Under this method, all costs associated with property acquisition
and exploration and development activities are capitalized into cost centers
that are established on a country-by-country basis. Capitalized costs within a
cost center, together with estimates of costs for future development,
dismantlement and abandonment, are amortized by the unit-of-production method
using the proved oil and gas reserves for each cost center. The Company's
investment in certain oil and gas properties is excluded from the amortization
base until the properties are evaluated. Gain or loss is recognized only on the
sale of oil and gas properties involving significant reserves. Proceeds from the
sale of insignificant reserves and undeveloped properties are applied to reduce
the costs in the cost centers. For each cost center, the capitalized costs are
subject to a limitation so as not to exceed the present value of future net
revenues from estimated production of proved oil and gas reserves, net of income
tax effect, plus the lower of cost or estimated fair value of unevaluated
properties included in the cost center. See Notes E and O for write-downs of oil
and gas properties in 1998. It is reasonably possible that the present value of
future net revenues from estimated production of proved oil and gas reserves
could be significantly reduced due to further decreases in oil and natural gas
prices since 1998 year-end. This could result in further write-downs of
capitalized costs of oil and gas properties in the near term.
Other Assets
The cost over the fair value of net assets acquired (goodwill) is amortized
by the straight-line method over 28 years for refining and marketing assets and
20 years for marine services assets.
Debt issue costs are deferred and amortized using the effective interest
method over the estimated terms of each instrument.
Income Taxes
Deferred tax assets and liabilities are recognized for future income tax
consequences attributable to differences between financial statement carrying
amounts of assets and liabilities and their respective tax bases. Measurement of
deferred tax assets and liabilities is based on enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in the period that includes
the enactment date.
Environmental Expenditures
Environmental expenditures that extend the life or increase the capacity of
facilities, or expenditures that mitigate or prevent environmental contamination
that is yet to occur, are capitalized. Expenditures that relate to an existing
condition caused by past operations, and which do not contribute to current or
future revenue generation, are expensed. Liabilities are recorded when
environmental assessments and/or remedial efforts are probable. Cost estimates
are based on the expected timing and extent of remedial actions required by
applicable governing agencies, experience gained from similar sites on which
environmental assessments or remediation have been completed, and the amount of
the Company's anticipated liability considering the proportional liability and
financial abilities of other responsible parties. Generally, the timing of these
accruals coincides with the completion of a feasibility study or the Company's
commitment to a formal plan of action. Estimated liabilities are not discounted
to present value.
Stock-Based Compensation
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board ("APB") No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Accordingly,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of the Company's Common Stock at the date of grant over the
amount an employee must
A-31
<PAGE> 58
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
pay to acquire the stock, except for stock options granted under the special
incentive compensation which became fully vested in May 1998 (see Note L).
New Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. SFAS No. 133
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The accounting for changes in the fair value of a derivative
depends on the intended use of the derivative and the resulting designation.
SFAS No. 133 is effective for all quarters of fiscal years beginning after June
15, 1999 and should not be applied retroactively to financial statements of
prior periods. From time to time, the Company enters into agreements to reduce
commodity price risks. Gains or losses on these hedging activities are
recognized when the related physical transactions are recognized as sales or
purchases. The Company is evaluating the effects that this new statement will
have on its financial condition, results of operations and financial reporting
and disclosures.
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income," which established standards for reporting and displaying comprehensive
income and its components in the financial statements. The Company did not have
any material amounts which would be reported separately from net income as
"other comprehensive income."
A-32
<PAGE> 59
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B -- EARNINGS PER SHARE
Basic earnings per share is determined by dividing net earnings applicable
to Common Stock by the weighted average number of common shares outstanding
during the period. The Company's calculation of diluted earnings per share takes
into account the effect of potentially dilutive shares, principally stock
options, outstanding during the period. The assumed conversion of Preferred
Stock to 8.75 million shares of Common Stock, or a weighted average of 4.37
million for the year ended December 31, 1998, produced an anti-dilutive result
and, in accordance with SFAS No. 128, was not included in the dilutive
calculation. Earnings (loss) per share calculations for the years ended December
31, 1998, 1997 and 1996 are presented below (in millions except per share
amounts):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------ ------
<S> <C> <C> <C>
BASIC:
Numerator:
Earnings (loss) before extraordinary item.............. $ (15.0) $ 30.7 $ 76.8
Extraordinary loss on extinguishments of debt, after
tax.................................................. (4.4) -- (2.3)
------- ------ ------
Net earnings (loss).................................... (19.4) 30.7 74.5
Less preferred dividends............................... 6.0 -- --
------- ------ ------
Net earnings (loss) applicable to common shares........ $ (25.4) $ 30.7 $ 74.5
======= ====== ======
Denominator:
Weighted average common shares outstanding............. 29.4 26.4 26.0
======= ====== ======
Basic earnings (loss) per share:
Before extraordinary item.............................. $ (0.71) $ 1.16 $ 2.96
Extraordinary loss, after tax.......................... (0.15) -- (0.09)
------- ------ ------
Net.................................................... $ (0.86) $ 1.16 $ 2.87
======= ====== ======
DILUTED:
Numerator:
Net earnings (loss) applicable to common shares........ $ (25.4) $ 30.7 $ 74.5
Plus income impact of assumed conversions of preferred
stock (only if dilutive)............................. -- -- --
------- ------ ------
Net earnings (loss).................................... $ (25.4) $ 30.7 $ 74.5
======= ====== ======
Denominator:
Weighted average common shares outstanding............. 29.4 26.4 26.0
Add potential dilutive securities:
Incremental dilutive shares from assumed conversion
of stock options and other (only if dilutive)..... -- 0.5 0.5
Incremental dilutive shares from assumed conversion
of preferred stock (only if dilutive)............. -- -- --
------- ------ ------
Total diluted shares................................... 29.4 26.9 26.5
======= ====== ======
Diluted earnings (loss) per share:
Before extraordinary item............................ $ (0.71) $ 1.14 $ 2.90
Extraordinary loss, after tax........................ (0.15) -- (0.09)
------- ------ ------
Net............................................... $ (0.86) $ 1.14 $ 2.81
======= ====== ======
</TABLE>
A-33
<PAGE> 60
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C -- ACQUISITIONS AND EXPANSIONS
Acquisitions of Hawaii Refinery and Washington Refinery
On May 29, 1998, the Company acquired (the "Hawaii Acquisition") all of the
outstanding capital stock of BHP Petroleum Americas Refining Inc. and BHP
Petroleum South Pacific Inc. (together, "BHP Hawaii") from BHP Hawaii Inc. and
BHP Petroleum Pacific Islands Inc. ("BHP Sellers"), affiliates of The Broken
Hill Proprietary Company Limited ("BHP"). The Hawaii Acquisition included a
95,000-barrel per day refinery (the "Hawaii Refinery") and 32 retail gasoline
stations in Hawaii. Tesoro and a BHP affiliate entered into a two-year crude
supply agreement pursuant to which the BHP affiliate will assist Tesoro in
acquiring crude oil feedstocks sourced outside of North America and arrange for
the transportation of such crude oil to the Hawaii Refinery. Tesoro paid $252.2
million in cash for the Hawaii Acquisition, including $77.2 million for working
capital. In addition, Tesoro issued an unsecured, non-interest bearing,
promissory note ("BHP Note") for $50 million. The present value of the BHP Note
amounted to $17.4 million, after the accelerated payment provision (see Note D),
and was recorded as part of the purchase price.
On August 10, 1998, the Company acquired (the "Washington Acquisition" and
together with the Hawaii Acquisition, the "Acquisitions") all of the outstanding
stock of Shell Anacortes Refining Company ("Shell Washington"), an affiliate of
Shell Oil Company ("Shell"). The Washington Acquisition included a
108,000-barrel per day refinery (the "Washington Refinery") in Anacortes,
Washington and related assets. The total cash purchase price for the Washington
Acquisition was $280.1 million, including $43.1 million for working capital.
The Acquisitions were accounted for as purchases whereby the purchase
prices were allocated to the assets acquired and liabilities assumed based upon
their respective fair market values at the dates of acquisition. Under purchase
accounting, financial results of the Acquisitions have been included in Tesoro's
consolidated financial statements since the dates of acquisition. Had these
results been included in Tesoro's results since January 1, 1997, and the
Refinancing and Offerings completed (as defined in Note D below), Tesoro's
consolidated results for the years ended December 31, 1998 and 1997, on a pro
forma basis, would have been as follows (in millions except per share amounts):
<TABLE>
<CAPTION>
1998 1997
-------- --------
(UNAUDITED)
<S> <C> <C>
Revenues.................................................... $2,270.8 $2,980.4
Earnings (loss) before extraordinary item................... $ (12.0) $ 30.5
Net earnings (loss)......................................... $ (16.4) $ 30.5
Earnings (loss) per share -- basic.......................... $ (0.88) $ 0.58
Earnings (loss) per share -- diluted........................ $ (0.88) $ 0.57
</TABLE>
The 1998 extraordinary loss on extinguishment of debt amounted to $0.14 per
share (basic and diluted) on a proforma basis.
See Note D for information related to financing the Acquisitions and Note M
for related environmental matters.
Alaska Refining and Marketing
In October 1997, the Company completed an expansion of its Alaska refinery
hydrocracker unit which enabled the Company to increase its jet fuel production.
The expansion, together with the addition of a new, high-yield jet fuel
hydrocracker catalyst, was completed at a cost of approximately $19 million.
In December 1997, the Company purchased the Union 76 marketing assets in
Southeast Alaska, consisting of one terminal, two retail stations and the rights
to use the Union 76 trademark within Alaska.
A-34
<PAGE> 61
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Marine Services
In February 1996, the Company purchased 100% of the capital stock of
Coastwide Energy Services, Inc. ("Coastwide"). The consideration included
approximately 1.4 million shares of Tesoro's Common Stock and $7.7 million in
cash. The market price of Tesoro's Common Stock was $9.00 per share at closing
of this transaction. Subsequent to the acquisition, Tesoro repaid approximately
$4.5 million of Coastwide's outstanding debt. The acquired operations provide
logistical support services and distribute petroleum products to the offshore
oil and gas industry in the Gulf of Mexico. The acquisition was accounted for as
a purchase whereby the purchase price was allocated to the assets acquired and
liabilities assumed based upon their estimated fair values.
Exploration and Production
In September 1998, the Company purchased oil and gas assets for $10
million, which included working interests in producing wells and undeveloped
acreage in the Morrow gas play located in Wheeler County in the Texas Panhandle,
together with undeveloped acres in prospective areas of the onshore Texas Gulf
Coast. In August 1998, the Company purchased a working interest in the Stiles
Ranch Field, located in Wheeler County in the Texas Panhandle, for $8 million in
cash plus the conveyance of a working interest in an undeveloped prospect owned
by the Company in South Texas. Also in 1998, the Company acquired additional
undeveloped acreage for $6 million, located primarily in the onshore Gulf Coast
of Texas and in Wheeler County in the Texas Panhandle.
In July 1997, the Company purchased the interests held by its former joint
venture participant in the then existing two contract blocks in southern
Bolivia, consisting of a 25% interest in Block 18 and a 27.4% interest in Block
20. The purchase price was approximately $20 million, which included $11.9
million for proved reserves and $3.3 million for undeveloped acreage with the
remainder for working capital and assumption of certain liabilities.
In the U.S., the Company purchased proved and unproved properties totaling
$22 million during 1997. These purchases included interests in fields in
southern Louisiana, South Texas and East Texas. During 1996, the Company
acquired proved and unproved properties totaling $25.7 million in South Texas
and East Texas.
For further information related to exploration and production activities,
see Note O.
NOTE D -- CAPITALIZATION
Credit Facility
In conjunction with closing the Hawaii Acquisition (see Note C) on May 29,
1998, Tesoro refinanced substantially all of its then-existing indebtedness
("Refinancing"). The Company recorded an extraordinary loss on early
extinguishment of debt of approximately $7.0 million pretax ($4.4 million
aftertax, or $0.15 per basic and diluted share) for the Refinancing during the
second quarter of 1998.
The total amount of funds required by Tesoro to complete the Hawaii
Acquisition and the Refinancing, to pay related fees and expenses and for
general corporate purposes was financed through a secured credit facility
("Interim Credit Facility"), which replaced the Company's previous corporate
revolving credit agreement. In the third quarter of 1998, the Company refinanced
all borrowings under the Interim Credit Facility with net proceeds from the
Offerings (as defined below) and borrowings under the Senior Credit Facility (as
defined below).
On July 2, 1998, and in connection with the Notes Offering (defined below)
and the Washington Acquisition, the Company entered into a senior credit
facility ("Senior Credit Facility") in the amount of $500 million. The Senior
Credit Facility is comprised of term loan facilities aggregating $200 million
(the "Tranche A Term Loans" and the "Tranche B Term Loan," collectively, the
"Term Loans") and a
A-35
<PAGE> 62
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
$300 million revolving credit and letter of credit facility ("Revolver"). The
Senior Credit Facility is guaranteed by substantially all of the Company's
active direct and indirect subsidiaries ("Guarantors") and is secured by
substantially all of the domestic assets of the Company and each of the
Guarantors. At December 31, 1998, the Company had outstanding borrowings of
$149.5 million under the Term Loans and $61.2 million under the Revolver.
Outstanding letters of credit totaled $14 million at December 31, 1998. Unused
availability under the Senior Credit Facility and Term Loans was approximately
$275 million at December 31, 1998. On January 4, 1999, the final $50 million
tranche under the Term Loans was borrowed and used to reduce borrowings under
the Revolver. The Revolver terminates on July 2, 2001, while the Term Loans
mature in varying quarterly installments through 2003. Maturities under the
Tranche A Term Loans, including the final $50 million borrowed in 1999,
aggregate to $10.0 million, $22.5 million, $25.0 million, $27.5 million and
$15.0 million in 1999, 2000, 2001, 2002 and 2003, respectively. Maturities of
outstanding borrowings under the Tranche B Term Loan equal $1 million annually
in 1999 through 2002 and $95.5 million in 2003.
The Senior Credit Facility requires the Company to maintain specified
levels of consolidated leverage and interest coverage and contains other
covenants and restrictions customary in credit arrangements of this kind. The
Company was in compliance with these covenants at December 31, 1998. Future
compliance with financial covenants under the Senior Credit Facility is
primarily dependent on the Company's cash flows and levels of borrowings under
the Revolver. Based on market conditions in the first quarter of 1999, including
depressed natural gas prices and downturn in refinery margins, continued
compliance with such covenants is not assured. If the Company is not able to
continue to comply with its financial covenants, it will be required to seek
waivers or amendments from its lenders. If such an event occurs, management of
the Company believes that it will be able to obtain waivers and/or negotiate
terms and conditions with its lenders under the Senior Credit Facility which
will allow the Company to adequately finance its operations.
The Revolver and the Tranche A Term Loans bear interest, at the Company's
election, at either the Base Rate (as defined in the Senior Credit Facility)
plus a margin ranging from 0.00% to 0.625% or the Eurodollar Rate (as defined in
the Senior Credit Facility) plus a margin ranging from 1.125% to 2.125%. The
Tranche B Term Loan bears interest, at the Company's election, at either the
Base Rate plus a margin ranging from 0.50% to 0.625% or the Eurodollar Rate plus
a margin ranging from 2.00% to 2.125%. At December 31, 1998, the interest rates
were 7.75% on the Revolver, 6.315% on the Tranche A Term Loans and 7.19% on the
Tranche B Term Loan.
The terms of the Senior Credit Facility allow for payment of cash dividends
on the Company's Common Stock not to exceed an aggregate of $10 million in any
year and also allow for payment of required dividends on its 7.25% Mandatorily
Convertible Preferred Stock.
Provisions of the Senior Credit Facility require prepayments to the Term
Loans, with certain defined exceptions, in an amount equal to: (i) 100% of the
net proceeds of certain incurred indebtedness; (ii) 100% of the net proceeds
received by the Company and its subsidiaries (other than certain net proceeds
reinvested in the business of the Company or its subsidiaries) from the
disposition of any assets, including proceeds from the sale of stock of the
Company's subsidiaries; and (iii) a percentage of excess cash flow, as defined,
depending on certain credit statistics. No prepayments were required for 1998.
Senior Subordinated Notes
On July 2, 1998, concurrently with the syndication of the Senior Credit
Facility, the Company issued $300 million aggregate principal amount of 9%
senior subordinated notes due 2008 through a private offering ("Notes
Offering"). Each $1,000 principal amount of its unregistered and outstanding
senior subordinated notes due 2008 was exchanged for $1,000 principal amount of
the Company's registered 9% Senior Subordinated Notes due 2008, Series B
("Senior Subordinated Notes") in September 1998. The Senior Subordinated Notes
have a ten-year maturity without sinking fund requirements and are subject to
optional redemption by the Company after five years at declining premiums. The
indenture ("Indenture") for the
A-36
<PAGE> 63
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Senior Subordinated Notes contains covenants and restrictions which are
customary for notes of this nature. The restrictions under the Indenture are
less restrictive than those in the Senior Credit Facility. To the extent the
Company's fixed charge coverage ratio, as defined in the Indenture, allows for
the incurrence of additional indebtedness, the Company will be allowed to pay
cash dividends on Common Stock. The effective interest rate on the Senior
Subordinated Notes is 9.16%, after giving effect to the discount at the date of
issue.
Common Stock and Preferred Stock
On May 14, 1998, the Company filed a universal shelf registration statement
("Shelf Registration") for $600 million of debt or equity securities for
acquisitions or general corporate purposes. The Company offered Premium Income
Equity Securities ("PIES") and Common Stock (collectively, the "Equity
Offerings" and together with the Notes Offering, the "Offerings") from the Shelf
Registration to provide partial funding for the Acquisitions discussed in Note
C. On July 1, 1998, the Company issued 9,000,000 PIES, representing fractional
interests in the Company's 7.25% Mandatorily Convertible Preferred Stock
("Preferred Stock"), with gross proceeds of approximately $143.4 million, and
5,000,000 shares of Common Stock, with gross proceeds of $79.7 million. Upon
exercise of the over-allotment options granted to the underwriters of the Equity
Offerings, on July 8, 1998, the Company issued 1,350,000 PIES with gross
proceeds of $21.5 million and 750,000 shares of Common Stock with gross proceeds
of $11.9 million. Holders of PIES are entitled to receive a cash dividend. The
PIES will automatically convert into shares of Common Stock on July 1, 2001, at
a rate based upon a formula dependent upon the market price of Common Stock.
Before July 1, 2001, each PIES is convertible, at the option of the holder
thereof, into 0.8455 shares of Common Stock, subject to adjustment in certain
events, such as Common Stock splits and stock dividends.
In connection with filing the Shelf Registration in May 1998, the Company's
Board of Directors approved terminating a repurchase program for Tesoro's Common
Stock that was initiated in May 1997. Under that program in 1997, the Company
used cash flows of $3.7 million to repurchase 236,800 shares of Common Stock.
For information relating to stock-based compensation and Common Stock
reserved for exercise of options and conversion of Preferred Stock, see Note L.
BHP Note
In connection with the Hawaii Acquisition (Note C), Tesoro issued an
unsecured, non-interest bearing, promissory note ("BHP Note") for the purchase
in the amount of $50 million, payable in five equal annual installments of $10
million each, beginning in 2009. The BHP Note provides for early payments to the
extent of one-half of the amount by which earnings from the Hawaii Acquisition,
before interest expense, income taxes and depreciation and amortization, as
specified in the BHP Note, exceed $50 million in any calendar year. Based on
1998 earnings from the Hawaii Acquisition, an early principal payment will be
made on the BHP Note in 1999. The present value of the BHP Note, discounted at
10% and including the effect of the early principal payment, was recorded as
part of the purchase price of the Hawaii Acquisition. The future effects of any
additional accelerated payments under the BHP Note, if required, would be
accounted for as additional cost of the acquired assets and amortized over the
remaining life of the assets.
State of Alaska
In 1993, the Company entered into an agreement ("Agreement") with the State
of Alaska ("State") that settled a contractual dispute with the State. Under the
Agreement, the Company was obligated to make variable monthly payments to the
State through December 2001 based on a per barrel charge on the volume of
feedstock processed through the Company's Alaska refinery crude unit. In 1997,
based on a per barrel throughput charge of 24 cents, the Company's variable
payment to the State totaled $4.4 million. In 1998, based on a per barrel
throughput charge of 30 cents, the Company's variable payments to the State
totaled
A-37
<PAGE> 64
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
$3.0 million. The per barrel charge increased to 30 cents in 1998 with one cent
annual incremental increases thereafter through 2001. The Agreement obligated
the Company to pay the State $60 million in January 2002; provided, however,
that such payment could be deferred indefinitely at the Company's option, by
continuing the variable monthly payments to the State beginning at 34 cents per
barrel for 2002 and increasing one cent per barrel annually thereafter. Under
the Agreement, variable monthly payments made after January 2002 would not
reduce the $60 million obligation to the State. The imputed rate of interest
used by the Company on the $60 million obligation was 13%.
Beginning June 1, 1998, the State released the Company from all payment
obligations, and all mortgages, liens and security interests in connection
therewith, under the Agreement in exchange for a payment of $66.1 million. The
Company is only obligated to continue payment of the per barrel throughput
charge through 2001 with respect to barrels of feedstock processed at the
refinery which exceed 50,000 barrels per day on a monthly basis, subject to
available credits (as defined in the Agreement) for amounts by which the barrels
of feedstock processed average less than 50,000 barrels per day on a monthly
basis.
Department of Energy
A Consent Order entered into by the Company with the Department of Energy
("DOE") in 1989 settled all issues relating to the Company's compliance with
federal petroleum price and allocation regulations from 1973 through decontrol
in 1981. At December 31, 1998, the Company's remaining obligation is to pay the
DOE $7.9 million, plus interest at 6%, over the next four years.
Hydrocracker Unit and Vacuum Unit Loans
In October 1997, the National Bank of Alaska ("NBA") and the Alaska
Industrial Development and Export Authority ("AIDEA"), under a loan agreement
("Hydrocracker Loan") entered into between the Company and NBA, provided a $16.2
million loan to the Company towards the cost of its Alaska refinery hydrocracker
expansion (see Note C). In 1994, NBA and the AIDEA provided a $15 million loan
to the Company towards the cost of the Company's Alaska refinery vacuum unit
("Vacuum Unit Loan"). The Hydrocracker Unit Loan and Vacuum Unit Loan were
repaid and terminated on May 29, 1998, in connection with the Refinancing
described above.
Capital Leases
Capital leases are primarily for tugs and barges used in transportation of
petroleum products within Hawaii. At December 31, 1998, the cost of capital
leases included in fixed assets was $9.3 million and the related accumulated
amortization was $0.9 million. Capital lease obligations included in long-term
debt totaled $9.8 million and $1.6 million at December 31, 1998 and 1997,
respectively.
1996 Repurchase of Debentures and Notes
In November 1996, the Company fully redeemed its two public debt issues,
totaling approximately $74 million, at a price equal to 100% of the principal
amount, plus accrued interest to the redemption date. The redemption of debt was
comprised of $44.1 million of outstanding 13% Exchange Notes and $30 million of
outstanding 12 3/4% Subordinated Debentures. The redemption was accounted for as
an early extinguishment of debt in the 1996 third quarter, resulting in a pretax
charge of $3.2 million ($2.3 million aftertax) which represented a write-off of
unamortized bond discount and issue costs.
A-38
<PAGE> 65
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Summary Table of Long-Term Debt and Other Obligations
Long-term debt and other obligations at December 31, 1998 and 1997
consisted of the following (in millions):
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Credit Facilities:
Revolving credit lines.................................... $ 61.2 $ 33.6
Tranche A Term Loan....................................... 50.0 --
Tranche B Term Loan....................................... 99.5 --
9% Senior Subordinated Notes (net of discount of $3.1)...... 296.9 --
BHP Note (net of discount of $31.8)......................... 18.2 --
Liability to State of Alaska................................ -- 62.0
Liability to Department of Energy........................... 7.9 9.2
Hydrocracker Loan........................................... -- 16.2
Vacuum Unit Loan............................................ -- 9.1
Other, primarily capital leases............................. 10.2 2.2
------ ------
543.9 132.3
Less current maturities..................................... 12.5 17.0
------ ------
Long-term debt, less current maturities..................... $531.4 $115.3
====== ======
</TABLE>
At December 31, 1998, aggregate maturities of outstanding long-term debt
and other obligations, including the Term Loans and Revolver, for each of the
five years following December 31, 1998 were as follows: 1999 - $12.5 million;
2000 - $14.6 million; 2001 - $78.5 million; 2002 - $18.4 million; and 2003 -
$104.1 million.
NOTE E -- OPERATING SEGMENTS
The Company's revenues are derived from three operating segments: Refining
and Marketing, Marine Services and Exploration and Production. Management has
identified these segments for managing operations and investing activities. The
segments are organized primarily by petroleum industry classification as
upstream (Exploration and Production) and downstream (Refining and Marketing,
and Marine Services). These classifications represent significantly different
activities with respect to investment, asset development, asset valuations,
production, maintenance, supply and market distribution. The downstream
businesses are organized into two operating segments representing (i) the
manufacturing and marketing of refined products and (ii) product distribution
and logistics services provided to the marine industry.
Refining and Marketing
Refining and Marketing operates three petroleum refineries located in
Alaska, Hawaii and Washington, which manufacture gasoline and gasoline
components, jet fuel, diesel fuel, heavy oils and residual products. These
products, together with products purchased from third parties, are sold at
wholesale through terminal facilities and other locations in Alaska, the Pacific
Northwest, Hawaii and American Samoa. In addition, Refining and Marketing
markets gasoline, other petroleum products and convenience store items through
Company-operated retail stations in Alaska and Hawaii. Refining and Marketing
also markets petroleum products through branded and unbranded stations located
in Alaska, Hawaii, American Samoa and the Pacific Northwest. Revenues from
export sales, primarily to Far East markets, amounted to $35.5 million, $16.1
million and $22.0 million in 1998, 1997 and 1996, respectively. The Company at
times resells previously purchased crude oil, sales of which amounted to $29.9
million, $44.4 million and $93.8 million in 1998, 1997 and 1996, respectively.
See Note C for information related to Acquisitions in this segment during 1998.
A-39
<PAGE> 66
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Marine Services
The Marine Services segment markets and distributes petroleum products,
water, drilling mud, and other supplies and services primarily to the marine and
offshore exploration and production industries operating in the Gulf of Mexico.
This segment currently operates through terminals along the Texas and Louisiana
Gulf Coast and on the U.S. West Coast.
Exploration and Production
The Exploration and Production segment is engaged in the exploration,
production and development of natural gas and oil in Texas, Louisiana and
Bolivia. This segment also includes the transportation of natural gas, including
the Company's production, to common carrier pipelines in South Texas. In
Bolivia, the Company operates under contracts with the Bolivian government to
explore for and produce hydrocarbons. The Company's Bolivian natural gas
production is sold under contract to the Bolivian government for export to
Argentina. The majority of the Company's Bolivian natural gas and oil reserves
are shut-in awaiting access to gas-consuming markets. A new, third-party
pipeline that will link Bolivia's gas reserves with markets in Brazil is
expected to begin operations in the second quarter of 1999.
In Exploration and Production, segment operating profit in 1998 included
fourth quarter write-downs of oil and gas properties totaling $68.3 million in
1998 ($28.4 million in the U.S. and $39.9 million in Bolivia) and other income
of $21.3 million in the second quarter representing funds received from an
operator that were no longer needed as a contingency reserve for litigation.
Segment operating profit in 1997 included income of $1.8 million for severance
tax refunds and $2.2 million related to the collection of a receivable for prior
years' Bolivian production. Segment operating profit in 1996 included $60
million of other income from termination of a natural gas contract and $5
million from retroactive severance tax refunds. In 1996, Exploration and
Production's segment operating profit also included $24.6 million from the
excess of natural gas contract prices over spot market prices (see Note F).
Other
Segment operating profit includes those revenues and expenses that are
directly attributable to management of the respective segment. For the years
presented, revenues were generated from sales to external customers, and
intersegment revenues were not significant. Income taxes, interest and financing
costs, interest income and corporate general and administrative expenses are not
included in determining segment operating profit. Corporate and unallocated
costs in 1998 included $19.9 million for special incentive compensation (see
Note L) and $33.0 million from interest and financing costs primarily related to
the Acquisitions (see Notes C and D).
EBITDA represents earnings before extraordinary items, interest and
financing costs expense, income taxes, write-downs of oil and gas properties and
depreciation, depletion and amortization. While not purporting to reflect any
measure of the Company's operations or cash flows, EBITDA is presented for
additional analysis. Operating segment EBITDA is equal to segment operating
profit before depreciation, depletion and amortization related to each segment.
A-40
<PAGE> 67
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Identifiable assets are those assets utilized by the segment. Corporate
assets are principally cash and other assets that are not directly associated
with the operations of a business segment. Segment information for the three
years ended December 31, 1998 is as follows (in millions):
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------ --------
<S> <C> <C> <C>
REVENUES
Gross operating revenues:
Refining and Marketing --
Refined products..................................... $1,198.2 $643.7 $ 620.8
Other, primarily crude oil resales and merchandise... 69.8 77.2 124.6
Marine Services........................................ 118.6 132.2 122.5
Exploration and Production --
U.S., including gas transportation................... 71.5 73.6 93.8
Bolivia.............................................. 10.5 11.2 13.7
-------- ------ --------
Total Gross Operating Revenues....................... 1,468.6 937.9 975.4
Other income.............................................. 21.7 5.5 64.4
-------- ------ --------
Total Revenues.................................... $1,490.3 $943.4 $1,039.8
======== ====== ========
SEGMENT OPERATING PROFIT (LOSS)
Refining and Marketing.................................... $ 69.7 $ 20.5 $ 6.0
Marine Services........................................... 8.6 6.3 6.1
Exploration and Production --
U.S., including gas transportation, before
write-down........................................... 45.9 37.3 123.9
Bolivia before write-down.............................. 3.4 8.6 8.8
Write-downs of oil and gas properties.................. (68.3) -- --
-------- ------ --------
Total Segment Operating Profit....................... 59.3 72.7 144.8
Corporate and Unallocated Costs........................... (74.8) (23.6) (29.7)
-------- ------ --------
Earnings (Loss) Before Income Taxes and Extraordinary
Item................................................... $ (15.5) $ 49.1 $ 115.1
======== ====== ========
EBITDA
Refining and Marketing.................................... $ 94.8 $ 33.2 $ 18.5
Marine Services........................................... 11.0 8.0 7.3
Exploration and Production --
U.S. .................................................. 81.8 67.1 149.5
Bolivia................................................ 6.0 10.1 10.1
-------- ------ --------
Total Operating Segment EBITDA....................... 193.6 118.4 185.4
Corporate and Unallocated................................. (40.7) (14.6) (10.6)
-------- ------ --------
Total Consolidated EBITDA............................ 152.9 103.8 174.8
Depreciation, Depletion and Amortization(a)............... (135.4) (46.4) (41.5)
Interest and Financing Costs.............................. (33.0) (8.3) (18.2)
-------- ------ --------
Earnings (Loss) Before Income Taxes and Extraordinary
Item................................................... $ (15.5) $ 49.1 $ 115.1
======== ====== ========
IDENTIFIABLE ASSETS
Refining and Marketing.................................... $1,077.7 $337.4 $ 317.0
Marine Services........................................... 59.2 59.3 56.0
Exploration and Production --
U.S., including gas transportation..................... 175.8 158.2 143.6
Bolivia................................................ 58.9 50.8 27.0
Corporate................................................. 56.8 22.1 39.0
-------- ------ --------
Total Assets........................................... $1,428.4 $627.8 $ 582.6
======== ====== ========
</TABLE>
A-41
<PAGE> 68
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------ --------
<S> <C> <C> <C>
DEPRECIATION, DEPLETION AND AMORTIZATION
Refining and Marketing.................................... $ 25.1 $ 12.7 $ 12.5
Marine Services........................................... 2.4 1.7 1.2
Exploration and Production --
U.S., including gas transportation(a).................. 64.3 29.8 25.6
Bolivia(a)............................................. 42.5 1.5 1.3
Corporate................................................. 1.1 0.7 0.9
-------- ------ --------
Total Depreciation, Depletion and Amortization......... $ 135.4 $ 46.4 $ 41.5
======== ====== ========
CAPITAL EXPENDITURES
Refining and Marketing(b)................................. $ 38.0 $ 43.9 $ 11.1
Marine Services........................................... 4.2 9.4 6.9
Exploration and Production --
U.S., including gas transportation..................... 87.5 65.4 59.7
Bolivia................................................ 47.6 27.5 6.9
Corporate................................................. 7.8 1.3 0.4
-------- ------ --------
Total Capital Expenditures............................. $ 185.1 $147.5 $ 85.0
======== ====== ========
</TABLE>
- ---------------
(a) Including 1998 write-downs of oil and gas properties of $28.4 million in the
U.S. and $39.9 million in Bolivia.
(b) Excluding 1998 Acquisitions of $536.5 million.
NOTE F -- OTHER INCOME AND EXPENSE
Other income and other expense for the years ended December 31, 1998, 1997
and 1996 included the following (in millions):
<TABLE>
<CAPTION>
1998 1997 1996
----- ---- -----
<S> <C> <C> <C>
Other Income:
Receipt of contingency funds.............................. $21.3 $ -- $ --
Retroactive severance tax refunds......................... -- 1.8 5.0
Collection of Bolivian receivable......................... -- 2.2 --
Natural gas contract settlement........................... -- -- 60.0
Gain (loss) on sale of assets and other................... 0.4 1.5 (0.6)
----- ---- -----
Total Other Income................................ $21.7 $5.5 $64.4
===== ==== =====
Other Operating Costs and Expenses:
Special incentive compensation............................ $ 7.9 $ -- $ --
===== ==== =====
Other Expense:
Special incentive compensation............................ $12.0 $ -- $ --
Depreciation and amortization -- Corporate................ 1.1 0.7 0.9
Shareholder consent solicitation.......................... -- -- 2.3
Other..................................................... 3.1 2.6 4.0
----- ---- -----
Total Other Expense............................... $16.2 $3.3 $ 7.2
===== ==== =====
</TABLE>
In 1998, the Exploration and Production segment received $21.3 million from
an operator in the Bob West Field, representing funds that were no longer needed
as a contingency reserve for litigation.
A-42
<PAGE> 69
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In 1996, the Company settled all claims and disputes with Tennessee Gas
Pipeline Company ("Tennessee Gas") and agreed to terminate the Tennessee Gas
contract effective October 1, 1996. The contract would have extended through
January 1999. Under the settlement, the Company received $51.8 million and the
right to recover severance taxes paid by Tennessee Gas of approximately $8.2
million, which resulted in income of $60 million to the Company in 1996. The
severance taxes were subsequently received in 1997.
In 1998, other expenses included $19.9 million for special incentive
compensation earned when the market price of the Company's stock achieved a
certain performance target (see Note L), of which $7.9 million was included in
other operating costs and expenses since it related to the operating segments.
NOTE G -- INCOME TAXES
The income tax provision (benefit) for the years ended December 31, 1998,
1997 and 1996 included the following (in millions):
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Federal -- Current.......................................... $ 5.4 $ 3.4 $16.2
Federal -- Deferred......................................... (9.7) 9.4 17.4
Foreign..................................................... 5.2 4.9 3.6
State....................................................... (1.4) 0.7 1.1
----- ----- -----
Income Tax Provision (Benefit)............................ $(0.5) $18.4 $38.3
===== ===== =====
</TABLE>
Deferred income taxes and benefits are provided for differences between
financial statement carrying amounts of assets and liabilities and their
respective tax bases. Temporary differences and the resulting deferred tax
liabilities and assets at December 31, 1998 and 1997 are summarized as follows
(in millions):
<TABLE>
<CAPTION>
1998 1997
----- -----
<S> <C> <C>
Deferred Federal Tax Liabilities:
Accelerated depreciation and property-related items....... $82.2 $57.8
Deferred charges and other................................ 5.6 --
----- -----
Total Deferred Federal Tax Liabilities................. 87.8 57.8
----- -----
Deferred Federal Tax Assets:
Investment tax and other credits.......................... 4.8 9.6
Accrued postretirement benefits........................... 17.2 10.5
Settlement with the Department of Energy.................. 2.8 3.2
Environmental reserve..................................... 3.3 3.1
Other..................................................... 1.1 5.3
----- -----
Total Deferred Federal Tax Assets...................... 29.2 31.7
----- -----
Net Deferred Federal Tax Liability.......................... 58.6 26.1
State Income and Other Taxes................................ 11.3 2.7
----- -----
Net Deferred Tax Liability................................ $69.9 $28.8
===== =====
</TABLE>
In 1998, the Acquisitions described in Note C resulted in net deferred
federal tax liabilities of $46.7 million and net deferred state liabilities of
$11.1 million as of the dates of acquisition.
A-43
<PAGE> 70
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following tables set forth domestic and foreign components of the
Company's results of operations (in millions) and a reconciliation of the normal
statutory federal income tax rate with the Company's effective tax rate
(percent):
<TABLE>
<CAPTION>
1998 1997 1996
------ ----- ------
<S> <C> <C> <C>
Earnings (Loss) Before Income Taxes and Extraordinary
Item:
U.S. ................................................... $ 20.2 $40.2 $106.7
Foreign................................................. (35.7) 8.9 8.4
------ ----- ------
Total Earnings (Loss) Before Income Taxes and
Extraordinary Item................................. $(15.5) $49.1 $115.1
====== ===== ======
Statutory U.S. Corporate Tax Rate......................... 35% 35% 35%
Effect of:
Foreign income taxes, net of tax benefit................ (26) 5 2
State income taxes, net of tax benefit.................. 1 1 1
Other................................................... (7) (4) (5)
------ ----- ------
Effective Income Tax Rate................................. 3% 37% 33%
====== ===== ======
</TABLE>
At December 31, 1998, the Company had approximately $3.5 million of
investment tax credits and employee stock ownership credits available for
carryover to subsequent years which, if not used, will expire in the years 1999
through 2006. Additionally, at December 31, 1998, the Company had approximately
$1.3 million of alternative minimum tax credit carryforwards, with no expiration
dates, to offset future regular tax liabilities.
NOTE H -- RECEIVABLES
Concentrations of credit risk with respect to accounts receivable are
limited, due to the large number of customers comprising the Company's customer
base and their dispersion across the Company's industry segments and geographic
areas of operations. The Company performs ongoing credit evaluations of its
customers' financial condition and in certain circumstances requires letters of
credit or other collateral arrangements. The Company's allowance for doubtful
accounts is reflected as a reduction of receivables in the Consolidated Balance
Sheets and amounted to $1.7 million and $1.4 million at December 31, 1998 and
1997, respectively.
NOTE I -- INVENTORIES
Components of inventories at December 31, 1998 and 1997 were as follows (in
millions):
<TABLE>
<CAPTION>
1998 1997
------ -----
<S> <C> <C>
Crude oil and wholesale refined products, at LIFO........... $182.4 $68.2
Merchandise and other refined products...................... 10.5 13.4
Materials and supplies...................................... 15.3 5.7
------ -----
Total inventories......................................... $208.2 $87.3
====== =====
</TABLE>
At December 31, 1998 and 1997, inventories valued using LIFO were lower
than replacement cost by approximately $3.3 million and $4.4 million,
respectively.
A-44
<PAGE> 71
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J -- ACCRUED LIABILITIES
The Company's current accrued liabilities and noncurrent other liabilities
as shown in the Consolidated Balance Sheets at December 31, 1998 and 1997
included the following (in millions):
<TABLE>
<CAPTION>
1998 1997
----- -----
<S> <C> <C>
Accrued Liabilities -- Current:
Accrued environmental costs............................... $ 6.9 $ 5.8
Accrued employee costs.................................... 21.5 12.4
Accrued taxes other than income taxes..................... 14.8 4.1
Accrued interest.......................................... 16.8 1.4
Other..................................................... 9.3 8.0
----- -----
Total Accrued Liabilities -- Current................... $69.3 $31.7
===== =====
Other Liabilities -- Noncurrent:
Accrued postretirement benefits........................... $49.1 $32.2
Accrued environmental costs............................... 2.4 2.7
Other..................................................... 8.2 8.3
----- -----
Total Other Liabilities -- Noncurrent.................. $59.7 $43.2
===== =====
</TABLE>
NOTE K -- BENEFIT PLANS
Pension Benefits and Other Postretirement Benefits
The Company sponsors multiple defined benefit pension plans which consist
of a retirement plan, executive security plans and a non-employee director
retirement plan.
The Company provides a qualified noncontributory retirement plan
("Retirement Plan") for all eligible employees. Plan benefits are based on years
of service and compensation. The Company's funding policy is to make
contributions at a minimum in accordance with the requirements of applicable
laws and regulations, but no more than the amount deductible for income tax
purposes. Retirement plan assets are primarily comprised of common stock and
bond funds. As a result of the Washington Acquisition, the Retirement Plan's
benefit obligation increased by $9.1 million during 1998.
The Company's executive security plans ("ESP Plans") provide executive
officers and other key personnel with supplemental death or retirement plans.
Such benefits are provided by two nonqualified, noncontributory plans and are
based on years of service and compensation. The Company makes contributions to
one plan based upon estimated requirements. Assets of the funded plan consist of
a group annuity contract.
The Company had previously established an unfunded non-employee director
retirement plan ("Director Retirement Plan") which provided eligible directors
retirement payments upon meeting certain age or other requirements. However, in
March 1997, the Board of Directors elected to freeze the Director Retirement
Plan and transfer accrued benefits of current directors to the Tesoro Petroleum
Corporation Board of Directors Phantom Stock Plan (see Note L). After the
amendment and transfer, only those retired directors or beneficiaries who had
begun to receive benefits remained participants in the Director Retirement Plan.
The projected benefit obligation, accumulated benefit obligation, and fair
value of plan assets for the pension plans with accumulated benefit obligations
in excess of plan assets were $85.7 million, $66.2 million and $59.1 million,
respectively as of December 31, 1998, and $54.6 million, $45.9 million, and
$51.0 million, respectively, as of December 31, 1997.
The Company provides health care and life insurance benefits to retirees
who were participating in the Company's group insurance program at retirement.
Health care is provided to qualified dependents of
A-45
<PAGE> 72
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
participating retirees. These benefits are provided through unfunded, defined
benefit plans. The health care plans are contributory, with retiree
contributions adjusted periodically, and contain other cost-sharing features
such as deductibles and coinsurance. The life insurance plan is noncontributory.
The Company funds its share of the cost of postretirement health care and life
insurance benefits on a pay-as-you go basis. As a result of the Acquisitions,
the postretirement health and life insurance benefit obligations increased by
$7.4 million during 1998.
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care and life insurance plans. A
one-percentage-point change in assumed health care cost trend rates could have
the following effects (in millions):
<TABLE>
<CAPTION>
1-PERCENTAGE- 1-PERCENTAGE-
POINT INCREASE POINT DECREASE
-------------- --------------
<S> <C> <C>
Effect on service and interest cost components........... $0.6 $(0.4)
Effect on postretirement benefit obligations............. $4.7 $(3.8)
</TABLE>
Financial information related to the Company's pension plans and other
postretirement benefits is presented below (in millions except percentages):
<TABLE>
<CAPTION>
PENSION BENEFITS POSTRETIREMENT BENEFITS
----------------- ------------------------
1998 1997 1998 1997
------- ------ --------- ---------
<S> <C> <C> <C> <C>
Change in benefit obligation:
Benefit obligation at beginning of year.............. $ 61.8 $57.5 $ 27.1 $ 25.9
Service cost......................................... 4.2 2.0 1.2 0.8
Interest cost........................................ 4.9 4.1 2.2 1.9
Actuarial (gain) loss................................ 20.3 4.7 5.0 (0.3)
Benefits paid........................................ (5.8) (6.7) (1.3) (0.6)
Acquisitions (see Note C)............................ 9.1 -- 7.4 --
Curtailments, special termination benefits and
other............................................. 0.1 0.2 -- (0.6)
------ ----- ------ ------
Benefit obligation at end of year................. 94.6 61.8 41.6 27.1
------ ----- ------ ------
Change in plan assets:
Fair value of plan assets at beginning of year....... 58.7 53.5 -- --
Actual return on plan assets......................... 8.4 9.4 -- --
Employer contributions............................... 8.4 3.0 -- --
Administrative expenses.............................. (0.6) (0.6) -- --
Benefits paid........................................ (5.8) (6.6) -- --
------ ----- ------ ------
Fair value of plan assets at end of year.......... 69.1 58.7 -- --
------ ----- ------ ------
Benefit obligations in excess of plan assets........... (25.5) (3.1) (41.6) (27.1)
Unrecognized prior service cost........................ 0.6 0.6 -- --
Unrecognized net transition asset...................... (0.5) (1.6) -- --
Unrecognized net actuarial (gain) loss................. 23.9 8.5 2.2 (2.8)
------ ----- ------ ------
Prepaid (accrued) benefit cost.................... $ (1.5) $ 4.4 $(39.4) $(29.9)
====== ===== ====== ======
Amounts recognized in consolidated balance sheets:
Accrued liabilities.................................. $ (9.7) $(2.3) $(39.4) $(29.9)
Prepaid benefit cost................................. 8.2 6.7 -- --
------ ----- ------ ------
Net amount recognized............................. $ (1.5) $ 4.4 $(39.4) $(29.9)
====== ===== ====== ======
</TABLE>
A-46
<PAGE> 73
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
PENSION BENEFITS POSTRETIREMENT BENEFITS
------------------------------------------ -----------------------
1998 1997 1996 1998 1997 1996
------------ ------------ ------------ ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Weighted average assumptions as
of December 31 (%):
Discount rate.................. 6.75 7.50 7.50 6.75 7.50 7.50
Rate of compensation
increase.................... 4.25 to 5.00 5.00 5.00 4.25 5.00 5.00
Expected return on plan
assets...................... 7.00 to 8.50 7.00 to 8.50 7.50 to 8.50 -- -- --
</TABLE>
For measurement purposes, the weighted average annual assumed rate of
increase in the per capita cost of covered health care benefits was assumed to
be 7.5% for 1998, decreasing gradually to 5% by the year 2010 and remaining
level thereafter.
<TABLE>
<CAPTION>
PENSION BENEFITS POSTRETIREMENT BENEFITS
--------------------- ------------------------
1998 1997 1996 1998 1997 1996
----- ----- ----- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Components of net periodic benefit cost:
Service cost.................................... $ 4.2 $ 2.0 $ 1.7 $1.2 $0.8 $0.7
Interest cost................................... 4.9 4.1 3.8 2.2 1.9 1.8
Expected return on plan assets.................. (4.2) (3.9) (3.7) -- -- --
Amortization of unrecognized transition asset... (1.1) (1.1) (1.1) -- -- --
Recognized net actuarial (gain) loss............ 1.0 0.9 0.6 -- -- --
Curtailments, settlements and special
termination benefits......................... 0.5 1.1 0.9 -- -- --
----- ----- ----- ---- ---- ----
Net periodic benefit cost.................. $ 5.3 $ 3.1 $ 2.2 $3.4 $2.7 $2.5
===== ===== ===== ==== ==== ====
</TABLE>
Thrift Plan
The Company sponsors an employee thrift plan ("Thrift Plan") which provides
for contributions by eligible employees into designated investment funds with a
matching contribution by the Company. Employees may contribute a portion of
their compensation, subject to certain limitations, and may elect tax deferred
treatment in accordance with the provisions of Section 401(k) of the Internal
Revenue Code. Effective September 1, 1998, the Thrift Plan was amended to change
the Company's 100% matching contribution, from a maximum of 4% to 6% of the
employee's eligible contribution, with at least 50% of the Company's matching
contribution invested in Common Stock of the Company. In addition, the maximum
employee contribution changed from 10% to 15%. The Company's contributions
amounted to $1.7 million, $1.2 million and $0.8 million during 1998, 1997 and
1996, respectively.
NOTE L -- STOCK-BASED COMPENSATION
Incentive Stock Plans
The Company has two employee incentive stock plans, the Amended and
Restated Executive Long-Term Incentive Plan ("1993 Plan") and Amended Incentive
Stock Plan of 1982 ("1982 Plan"), and the 1995 Non-Employee Director Stock
Option Plan ("1995 Plan") (collectively, the "Plans").
Shares of Common Stock may be granted under the 1993 Plan in a variety of
forms, including restricted stock, incentive stock options, nonqualified stock
options, stock appreciation rights and performance share and performance unit
awards. In 1998, the aggregate number of shares of Common Stock which can be
granted under the 1993 Plan was increased from 2,650,000 to 4,250,000. Stock
options may be granted at exercise prices not less than the fair market value on
the date the options are granted. The options granted generally become
exercisable after one year in 20%, 25% or 33% increments per year and expire ten
years from the date
A-47
<PAGE> 74
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
of grant. The 1993 Plan will expire, unless earlier terminated, as to the
issuance of awards in the year 2003. At December 31, 1998, the Company had
893,880 shares available for future grants under the 1993 Plan.
The 1982 Plan expired in 1994 as to issuance of stock appreciation rights,
stock options and stock awards; however, grants made before the expiration date,
that have not been fully exercised, remain outstanding pursuant to their terms.
The 1995 Plan provides for the grant of up to an aggregate of 150,000
nonqualified stock options to eligible non-employee directors of the Company.
These automatic, non-discretionary stock options are granted at an exercise
price equal to the fair market value per share of the Company's Common Stock as
of the date of grant. Under the 1995 Plan, each person serving as a non-employee
director on February 23, 1995, or elected thereafter, initially receives an
option to purchase 5,000 shares of Common Stock. Thereafter, each non-employee
director, while the 1995 Plan is in effect and shares are available to grant,
will be granted an option to purchase 1,000 shares of Common Stock on the next
day after each annual meeting of the Company's stockholders but not later than
June 1, if no annual meeting is held. The term of each option is ten years, and
an option first becomes exercisable six months after the date of grant. The 1995
Plan will terminate as to issuance of stock options in February 2005. At
December 31, 1998, the Company had 62,000 options outstanding and 71,000 shares
available for future grants under the 1995 Plan.
A summary of stock option activity in the Plans is set forth below
(thousands of shares):
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED-
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
----------- ----------------
<S> <C> <C>
Outstanding January 1, 1996.............................. 1,172.1 $ 7.16
Granted................................................ 1,095.5 13.45
Exercised.............................................. (315.7) 5.67
Forfeited and expired.................................. (95.2) 8.50
-------
Outstanding December 31, 1996............................ 1,856.7 11.05
Granted................................................ 431.0 16.73
Exercised.............................................. (43.8) 8.45
Forfeited and expired.................................. (36.0) 8.40
-------
Outstanding December 31, 1997............................ 2,207.9 12.26
Granted................................................ 801.2 15.94
Exercised.............................................. (34.1) 10.42
Forfeited and expired.................................. (23.4) 12.16
-------
Outstanding December 31, 1998............................ 2,951.6 13.28
=======
</TABLE>
At December 31, 1998, 1997 and 1996, exercisable stock options totaled 1.4
million, 0.7 million and 0.4 million, respectively.
A-48
<PAGE> 75
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information about stock options outstanding
under the Plans at December 31, 1998 (thousands of shares):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED-AVERAGE -------------------------------
RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
--------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$ 3.92 to $ 7.19..... 175.8 4.2 years $ 4.50 175.8 $ 4.50
$ 7.20 to $10.45..... 523.0 6.5 years 8.63 360.9 8.73
$10.46 to $13.72..... 394.0 7.4 years 11.41 373.0 11.40
$13.73 to $16.98..... 1,858.8 8.9 years 15.82 510.3 15.35
------- -------
$ 3.92 to $16.98..... 2,951.6 8.0 years 13.28 1,420.0 11.29
======= =======
</TABLE>
Phantom Stock Agreement and Phantom Stock Plan
In 1997, the Compensation Committee of the Board of Directors granted
175,000 phantom stock options to an executive officer of the Company at 100% of
the fair market value of the Company's Common Stock on the grant date, or
$16.9844 per share. These phantom stock options vest in 15% increments in each
of the first three years and the remaining 55% increment vests in the fourth
year. At December 31, 1998, 26,250 of these phantom stock options were
exercisable. Upon exercise, the executive officer would be entitled to receive
in cash the difference between the fair market value of the Common Stock on the
date of the phantom stock option grant and the fair market value of Common Stock
on the date of exercise. At the discretion of the Compensation Committee, these
phantom stock options may be converted to traditional stock options under the
1993 Plan.
To more closely align director compensation with shareholders' interests,
in March 1997, the lump-sum accrued benefit of each of the current non-employee
directors was transferred from the Director Retirement Plan (see Note K) into an
account ("Account") in the Company's Board of Directors Deferred Phantom Stock
Plan ("Phantom Stock Plan"). Under the Phantom Stock Plan, a yearly credit of
$7,250 (prorated to $6,042 for 1997) is made to the Account of each director in
units, based upon the closing market price of the Company's Common Stock on the
date of credit. In addition, a director may elect to have the value of his cash
retainer fee deposited quarterly into the Account in units. The value of each
Account balance, which is a function of the amount, if any, by which the market
value of the Company's Common stock changes, is payable in cash at retirement,
death, disability or termination, if vested. In 1998, the Company credited
expense for approximately $110,000 related to the Phantom Stock Plan due to the
net depreciation in the market price of the Company's Common Stock. In 1997, the
Company recorded expense of approximately $127,000 due to the increase in the
market price of the Company's Common Stock.
Incentive Compensation
In October 1998, the Company's Board of Directors unanimously approved the
1998 Performance Incentive Compensation Plan ("1998 Performance Plan"), which is
intended to advance the best interests of the Company and its stockholders by
directly targeting Company performance to align with the ninetieth percentile
historical stock-price growth rate for the Company's peer group. In addition,
the 1998 Performance Plan will provide the Company's employees with additional
compensation, contingent upon achievement of the targeted objectives, thereby
encouraging them to continue in the employ of the Company. Under the 1998
Performance Plan, targeted objectives are comprised of the fair market value of
the Company's Common Stock equaling or exceeding an average of $35 per share
("First Performance Target") and $45 per share ("Second Performance Target") on
any 20 consecutive trading days during a period commencing on October 1, 1998
and ending on the earlier of September 30, 2002, or the date on which the Second
Performance Target is achieved ("Performance Period"). The 1998 Performance Plan
has several tiers of
A-49
<PAGE> 76
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
awards, with the award generally determined by job level. Most eligible
employees have contingent cash bonus opportunities of 25% of their annual "basic
compensation" (as defined in the 1998 Performance Plan) and three executive
officers have contingent awards totaling 655,000 shares of phantom stock which
will be payable solely in cash. Upon achievement of the First Performance
Target, one-fourth of the contingent award will be earned, with payout deferred
until the end of the Performance Period. The remaining 75% will be earned only
upon achievement of the Second Performance Target, with payout occurring 30 days
thereafter. Employees will need to have at least one year of regular, full-time
service at the time the Performance Period ends in order to be eligible for a
payment. The Company estimates that it will incur aftertax costs of
approximately 1% of the total aggregate increase in shareholder value if the
First Performance Target is reached and will incur an additional 2% aftertax
charge if the Second Performance Target is reached.
Under a previous special incentive compensation strategy, approved
unanimously by the Company's Board of Director in June 1996, eligible employees
were provided with incentives to achieve a significant increase in the market
price of the Company's Common Stock. Under this strategy, awards were earned
when the market price of the Company's Common Stock reached an average price per
share of $20 or higher over 20 consecutive trading days after June 30, 1997 and
before December 31, 1998 ("Performance Target"). In connection with this
strategy, certain executives were granted, from the Company's 1993 Plan, a total
of 340,000 stock options at an exercise price of $11.375 per share, the fair
market value (as defined in the 1993 Plan) of a share of the Company's Common
Stock on the date of grant, and 350,000 shares of restricted Common Stock, all
of which vested upon achieving the Performance Target in May of 1998.
Non-executive employees earned cash bonuses equal to 25% of their individual
payroll amounts for the previous twelve complete months. In May 1998, the
Company recorded a pretax charge of approximately $20 million ($10 million
related to the noncash vesting of restricted stock awards and stock options and
$10 million for cash bonuses) for this strategy. On an aftertax basis, the
charge totaled approximately $13 million, representing approximately 5% of the
total aggregate increase in shareholder value since approval of the special
incentive strategy in 1996.
Pro Forma Information
The Company applies APB No. 25 and related interpretations in accounting
for its stock-based compensation. Had compensation cost been determined based on
the fair value at the grant dates for awards in accordance with SFAS No. 123,
"Accounting for Stock-Based Compensation," the Company's pro forma results in
1998, 1997 and 1996 would have been a net loss of approximately $22.3 million
($0.96 per basic and diluted share), net earnings of $28.5 million ($1.08 per
basic share, $1.06 per diluted share) and net earnings of $72.6 million ($2.79
per basic share, $2.74 per diluted share), respectively. The fair value of each
option grant was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions: expected
volatility of 49%, 32% and 30%; risk free interest rates of 4.7%, 6.7% and 6.6%;
expected lives of seven years; and no dividend yields for 1998, 1997 and 1996,
respectively. The estimated average fair value per share of options granted
during 1998, 1997 and 1996 were $7.85, $5.96 and $4.26, respectively. The fair
value of phantom stock awards in 1998 was $0.82 per share and the fair value of
restricted stock awards in 1996 was $0.95 per share.
Shares Reserved
Shares of unissued Common Stock reserved for the Plans were 3,928,466 at
December 31, 1998. In addition, at December 31, 1998, 8,750,925 shares of
unissued Common Stock were reserved for the conversion of Preferred Stock (see
Note D).
A-50
<PAGE> 77
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M -- COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has various noncancellable operating leases related to
buildings, equipment, property and other facilities. These long-term leases have
remaining primary terms generally up to ten years, with terms of certain
rights-of-way extending up to 34 years, and generally contain multiple renewal
options. Future minimum annual lease payments as of December 31, 1998, for
operating leases having initial or remaining noncancelable lease terms in excess
of one year, excluding marine charters, were as follows (in millions):
<TABLE>
<S> <C>
1999........................................................ $ 14.4
2000........................................................ 12.5
2001........................................................ 11.8
2002........................................................ 10.5
2003........................................................ 10.3
Remainder................................................... 117.0
------
Total Minimum Lease Payments........................... $176.5
======
</TABLE>
In addition to the long-term lease commitments above, the Company has
leases for two vessels that are primarily used to transport crude oil and
refined products to and from the Company's refineries. At December 31, 1998,
future minimum annual lease payments remaining for these two vessels, which
include operating costs, are approximately $28 million for 1999 and $16 million
for 2000. Operating costs related to these vessels, which may vary from year to
year, comprised approximately 30% of the total minimum payments during 1998. The
Company also enters into various month-to-month and other short-term rentals,
including three charters for vessels primarily used to transport refined
products from the Company's refineries to the Far East and South Pacific. The
Company also leases tugs and barges for Hawaii operations under capital leases
(see Note D). Under these leases, the Company pays operating costs, including
personnel, repairs, maintenance and dry-docking, estimated at $9 million for
1999.
Total rental expense for short-term and long-term leases, excluding marine
charters, amounted to approximately $20 million, $11 million and $12 million for
1998, 1997 and 1996, respectively. In addition, expenses related to charters of
marine vessels were $34 million in 1998 and 1997 and $30 million in 1996.
In November 1998, the Company entered into a lease agreement to become the
sole tenant of an office building to be constructed in 1999. Upon substantial
completion of the building, annual base lease commitments will range from $1.8
million to $2.4 million over a 15-year lease term.
Environmental
The Company is subject to extensive federal, state and local environmental
laws and regulations. These laws, which change frequently, regulate the
discharge of materials into the environment and may require the Company to
remove or mitigate the environmental effects of the disposal or release of
petroleum or chemical substances at various sites or install additional controls
or other modifications or changes in use for certain emission sources.
The Company is currently involved with the Environmental Protection Agency
("EPA") regarding a waste disposal site near Abbeville, Louisiana and the
Casmalia Disposal Site in Santa Barbara County, California. The Company has been
named a potentially responsible party ("PRP") under the Federal Comprehensive
Environmental Response, Compensation and Liability Act ("CERCLA" or "Superfund")
at both sites. Although the Superfund law might impose joint and several
liability upon each party at the sites, the extent of the Company's allocated
financial contribution for cleanup is expected to be de minimis based upon the
number of companies, volumes of waste involved and total estimated costs to
close each site. The Company believes, based on these considerations and
discussions with the EPA, that its liability at the
A-51
<PAGE> 78
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Abbeville site will not exceed $25,000. The Company believes that its liability
at the Casmalia Site is de minimis based on a 1999 notification from the EPA
indicating that the Company's liability will not exceed $125,000.
The Company is currently involved with a waste water disposal site in
Redwood City, California. On December 18, 1998, the Port of Redwood City filed
suit against numerous defendants, including the Company, for contribution
pursuant to CERCLA and the Resource Conservation and Recovery Act ("RCRA"). The
Company has negotiated with the Port of Redwood City and expects to settle its
liability in early 1999. The Company believes that it is not subject to joint
and several liability for the cleanup of the site and that its liability will
not exceed $40,000.
In connection with the Hawaii Acquisition discussed in Note C, the BHP
Sellers and the Company have executed a separate environmental agreement,
whereby the BHP Sellers have indemnified the Company for environmental costs
arising out of conditions which existed at or prior to closing. This
indemnification is subject to a maximum limit of $9.5 million and expires after
a period of ten years. Under the environmental agreement, the first $5.0 million
of these liabilities will be the responsibility of the BHP Sellers and the next
$6.0 million will be shared on the basis of 75% by the BHP Sellers and 25% by
the Company. Certain environmental claims arising out of prior operations will
not be subject to the $9.5 million limit or the ten-year time limit.
Under the agreement related to the Washington Acquisition discussed in Note
C, Shell Refining Holding Company, a subsidiary of Shell (the "Shell Seller"),
generally has agreed to indemnify the Company for environmental liabilities at
the Washington Refinery arising out of conditions which existed at or prior to
the closing date and identified by the Company prior to August 1, 2001. The
Company is responsible for environmental costs up to the first $0.5 million each
year, after which the Shell Seller will be responsible for annual environmental
costs up to $1.0 million. Annual costs greater than $1.0 million will be shared
equally between the Company and the Shell Seller, subject to an aggregate
maximum of $5.0 million and a ten-year term.
The Company is also involved in remedial responses and has incurred cleanup
expenditures associated with environmental matters at a number of sites,
including certain of its own properties. At December 31, 1998, the Company's
accruals for environmental expenses amounted to $9.3 million. Based on currently
available information, including the participation of other parties or former
owners in remediation actions, the Company believes these accruals are adequate.
To comply with environmental laws and regulations, the Company anticipates
that it will make capital improvements of approximately $12 million in 1999 and
$5 million in 2000. In addition, capital expenditures for alternative secondary
containment systems for existing storage tank facilities are estimated to be $2
million in 1999 and $1 million in 2000, with a remaining $4 million expected to
be spent by 2002.
Conditions that require additional expenditures may exist for various
Company sites, including, but not limited to, the Company's refineries, retail
gasoline stations (operating and closed locations) and petroleum product
terminals, and for compliance with the Clean Air Act and other state and federal
regulations. The amount of such future expenditures cannot currently be
determined by the Company.
Other
On October 1, 1998, the Attorney General for the State of Hawaii filed a
lawsuit in the U.S. District Court for the District of Hawaii against thirteen
oil companies, including Tesoro Petroleum Corporation and Tesoro Hawaii
Corporation, alleging anti-competitive marketing practices in violation of
federal and state anti-trust laws, and seeking injunctive relief and
compensatory and treble damages and civil penalties against all defendants in an
amount in excess of $500 million. On March 25, 1999, the Attorney General filed
an amended complaint with the U.S. District Court seeking damages against all
defendants for such alleged
A-52
<PAGE> 79
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
anti-competitive marketing practices in an amount in excess of $1.3 billion. The
Company believes that it has not engaged in any anti-competitive activities and
will defend this litigation vigorously. This proceeding is subject to the
indemnity provision of the stock sale agreement between the BHP Sellers and the
Company which provides for indemnification in excess of $2 million and not to
exceed $65 million.
NOTE N -- QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
QUARTERS
------------------------------------ TOTAL
FIRST SECOND THIRD FOURTH YEAR
------ ------ ------ ------ --------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
1998
Revenues:
Gross operating revenues................ $195.2 $258.3 $472.5 $542.6 $1,468.6
Other income............................ 0.8 20.6 0.2 0.1 21.7
------ ------ ------ ------ --------
Total Revenues..................... $196.0 $278.9 $472.7 $542.7 $1,490.3
====== ====== ====== ====== ========
Segment Operating Profit (Loss)............ $ 17.9 $ 50.8 $ 28.6 $(38.0) $ 59.3
====== ====== ====== ====== ========
Net Earnings (Loss)........................ $ 6.1 $ 6.2 $ 7.8 $(39.5) $ (19.4)
====== ====== ====== ====== ========
Net Earnings (Loss) Per Share -- Basic..... $ 0.23 $ 0.23 $ 0.15 $(1.32) $ (0.86)
Net Earnings (Loss) Per Share -- Diluted... $ 0.23 $ 0.23 $ 0.15 $(1.32) $ (0.86)
1997
Revenues:
Gross operating revenues................ $233.3 $210.7 $251.0 $242.9 $ 937.9
Other income............................ 1.6 2.6 0.4 0.9 5.5
------ ------ ------ ------ --------
Total Revenues..................... $234.9 $213.3 $251.4 $243.8 $ 943.4
====== ====== ====== ====== ========
Segment Operating Profit................... $ 15.0 $ 19.9 $ 19.4 $ 18.4 $ 72.7
====== ====== ====== ====== ========
Net Earnings............................... $ 6.1 $ 9.7 $ 8.0 $ 6.9 $ 30.7
====== ====== ====== ====== ========
Net Earnings Per Share -- Basic............ $ 0.23 $ 0.36 $ 0.30 $ 0.26 $ 1.16
Net Earnings Per Share -- Diluted.......... $ 0.23 $ 0.36 $ 0.30 $ 0.26 $ 1.14
</TABLE>
The 1998 second quarter included pretax other income of $21.3 million for
receipt of funds from an operator and a pretax charge of $19.9 million for
special incentive compensation (Note L). In addition, an aftertax extraordinary
loss of $4.4 million was recorded in the 1998 second quarter for the early
extinguishment of debt (Note D). During the 1998 fourth quarter, pretax
write-downs of oil and gas properties totaled $68.3 million (Notes A and O).
Earnings per share in the 1998 third and fourth quarters were reduced by the
effects of dividends on Preferred Stock issued in July 1998.
Other income in 1997 included severance tax refunds of $1.6 million and
$0.2 million in the first and second quarters, respectively. Other income of
$2.2 million related to the collection of a Bolivian receivable for prior years'
production was recorded in the 1997 second quarter.
A-53
<PAGE> 80
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE O -- OIL AND GAS PRODUCING ACTIVITIES
The information presented below represents the oil and gas producing
activities of the Company's Exploration and Production segment, excluding
amounts related to its U.S. natural gas transportation operations. Other
information pertinent to the Exploration and Production segment is contained in
Notes C and E.
Capitalized Costs Relating to Oil and Gas Producing Activities
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1997 1996
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Capitalized Costs:
Proved properties...................................... $393.3 $251.6 $179.4
Unproved properties not being amortized................ 25.1 31.9 12.4
------ ------ ------
418.4 283.5 191.8
Accumulated depreciation, depletion and amortization... 221.9 112.5 78.2
------ ------ ------
Net Capitalized Costs............................... $196.5 $171.0 $113.6
====== ====== ======
</TABLE>
The Company's investment in oil and gas properties included $25 million in
unevaluated properties, primarily undeveloped leasehold costs and seismic costs,
which have been excluded from the amortization base at December 31, 1998. Of
this amount, $14 million, $8 million and $3 million of such costs were incurred
in 1998, 1997 and 1996, respectively. The Company anticipates that the majority
of these costs will be included in the amortization base during the next three
years.
During the fourth quarter of 1998, the Company wrote down its capitalized
costs of oil and gas properties by $68.3 million ($28.4 million in U.S. and
$39.9 million in Bolivia). These write-downs, which were required by the cost
ceiling limitation under full-cost accounting, were primarily the result of
declines in oil and gas prices during the fourth quarter of 1998.
Costs Incurred in Oil and Gas Property Acquisition, Exploration and
Development Activities
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
------- ------- ------
(IN MILLIONS)
<S> <C> <C> <C>
1998
Property acquisitions --
Proved................................................ $17.8 $ -- $ 17.8
Unproved.............................................. 6.8 -- 6.8
Exploration.............................................. 32.0 28.3 60.3
Development.............................................. 29.2 13.2 42.4
----- ----- ------
$85.8 $41.5 $127.3
===== ===== ======
1997
Property acquisitions --
Proved................................................ $14.7 $11.9 $ 26.6
Unproved.............................................. 7.1 3.3 10.4
Exploration.............................................. 24.6 11.0 35.6
Development.............................................. 17.8 1.3 19.1
----- ----- ------
$64.2 $27.5 $ 91.7
===== ===== ======
</TABLE>
A-54
<PAGE> 81
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
------- ------- ------
(IN MILLIONS)
<S> <C> <C> <C>
1996
Property acquisitions --
Proved................................................ $20.5 $ -- $ 20.5
Unproved.............................................. 5.2 -- 5.2
Exploration.............................................. 11.8 6.7 18.5
Development.............................................. 22.2 0.2 22.4
----- ----- ------
$59.7 $ 6.9 $ 66.6
===== ===== ======
</TABLE>
Results of Operations from Oil and Gas Producing Activities
The following table sets forth the results of operations for oil and gas
producing activities, in the aggregate by geographic area, with income tax
expense computed using the statutory tax rate for the period adjusted for
permanent differences, tax credits and allowances.
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
-------- --------- --------
(IN MILLIONS EXCEPT AS INDICATED)
<S> <C> <C> <C>
1998
Gross revenues -- sales to unaffiliates(a)............. $ 68.1 $ 10.5 $ 78.6
Production costs....................................... 9.7 1.2 10.9
Administrative support and other....................... 1.9 2.8 4.7
Depreciation, depletion and amortization............... 35.6 2.6 38.2
Write-downs of oil and gas properties.................. 28.4 39.9 68.3
Other income (expense)(b).............................. 22.4 (0.5) 21.9
------ ------ ------
Pretax results of operations........................... 14.9 (36.5) (21.6)
Income tax expense (benefit)........................... 5.2 (9.4) (4.2)
------ ------ ------
Results of operations from producing activities(c)..... $ 9.7 $(27.1) $(17.4)
====== ====== ======
Depletion per net equivalent thousand cubic feet
("Mcfe")............................................ $ 1.04 $ 0.25
====== ======
1997
Gross revenues -- sales to unaffiliates(a)............. $ 68.8 $ 11.2 $ 80.0
Production costs....................................... 7.4 0.9 8.3
Administrative support and other....................... 2.2 2.4 4.6
Depreciation, depletion and amortization............... 29.3 1.5 30.8
Other income(b)........................................ 3.2 2.2 5.4
------ ------ ------
Pretax results of operations........................... 33.1 8.6 41.7
Income tax expense..................................... 11.6 4.9 16.5
------ ------ ------
Results of operations from producing activities(c)..... $ 21.5 $ 3.7 $ 25.2
====== ====== ======
Depletion per Mcfe..................................... $ 0.93 $ 0.19
====== ======
</TABLE>
A-55
<PAGE> 82
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
-------- --------- --------
(IN MILLIONS EXCEPT AS INDICATED)
<S> <C> <C> <C>
1996
Gross revenues -- sales to unaffiliates(a)............. $ 88.3 $ 13.7 $102.0
Production costs....................................... 5.3 0.9 6.2
Administrative support and other....................... 3.6 2.8 6.4
Depreciation, depletion and amortization............... 25.2 1.3 26.5
Income from settlement of a natural gas contract....... 60.0 -- 60.0
Income from severance tax refunds...................... 5.0 -- 5.0
------ ------ ------
Pretax results of operations........................... 119.2 8.7 127.9
Income tax expense..................................... 41.7 5.4 47.1
------ ------ ------
Results of operations from producing activities(c)..... $ 77.5 $ 3.3 $ 80.8
====== ====== ======
Depletion per Mcfe..................................... $ 0.79 $ 0.15
====== ======
</TABLE>
- ---------------
(a) Revenues included the effects of natural gas commodity price agreements
which amounted to a gain of $1.3 million ($0.04 per thousand cubic feet
("Mcf")) in 1998 and to losses of $1.6 million ($0.05 per Mcf) and $3.1
million ($0.11 per Mcf) in 1997 and 1996, respectively. The Company had
entered into these agreements to reduce risks caused by fluctuations in the
prices of natural gas in the spot market. During 1998, 1997 and 1996, the
Company used such agreements to set the price of 13%, 9%, and 30%,
respectively, of the natural gas that it sold in the spot market. At
year-end, the Company had natural gas price agreements outstanding through
March 31, 1999.
(b) Other income included $21.3 million in 1998 from an operator in the Bob West
Field, representing funds that are no longer needed as a contingency reserve
for litigation. Other income in 1997 primarily represented retroactive
severance tax refunds in the U.S. and income related to a collection of a
receivable in Bolivia.
(c) Excludes corporate general and administrative expenses and financing costs.
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved
Reserves (Unaudited)
The following table sets forth the computation of the standardized measure
of discounted future net cash flows relating to proved reserves and the changes
in such cash flows in accordance with SFAS No. 69. The standardized measure is
the estimated excess future cash inflows from proved reserves less estimated
future production and development costs, estimated future income taxes and a
discount factor. Future cash inflows represent expected revenues from production
of year-end quantities of proved reserves based on year-end prices and any fixed
and determinable future escalation provided by contractual arrangements in
existence at year-end. Escalation based on inflation, federal regulatory changes
and supply and demand are not considered. Estimated future production costs
related to year-end reserves are based on year-end costs. Such costs include,
but are not limited to, production taxes and direct operating costs. Inflation
and other anticipatory costs are not considered until the actual cost change
takes effect. Estimated future income tax expenses are computed using the
appropriate year-end statutory tax rates. Consideration is given for the effects
of permanent differences, tax credits and allowances. A discount rate of 10% is
applied to the annual future net cash flows.
The methodology and assumptions used in calculating the standardized
measure are those required by SFAS No. 69. The standardized measure is not
intended to be representative of the fair market value of the Company's proved
reserves. The calculations of revenues and costs do not necessarily represent
the amounts to be received or expended by the Company.
A-56
<PAGE> 83
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
------ ------- ------
(IN MILLIONS)
<S> <C> <C> <C>
DECEMBER 31, 1998
Future cash inflows....................................... $330.4 $275.0 $605.4
Future production costs................................... 77.8 60.9 138.7
Future development costs.................................. 24.4 70.6 95.0
------ ------ ------
Future net cash flows before income tax expense........... 228.2 143.5 371.7
10% annual discount factor................................ 88.3 73.7 162.0
------ ------ ------
Discounted future net cash flows before income taxes...... 139.9 69.8 209.7
Discounted future income tax expense(a)................... 27.9 41.4 69.3
------ ------ ------
Standardized measure of discounted future net cash
flows.................................................. $112.0 $ 28.4 $140.4
====== ====== ======
DECEMBER 31, 1997
Future cash inflows....................................... $347.9 $490.3 $838.2
Future production costs................................... 81.0 86.5 167.5
Future development costs.................................. 29.4 48.8 78.2
------ ------ ------
Future net cash flows before income tax expense........... 237.5 355.0 592.5
10% annual discount factor................................ 70.0 148.5 218.5
------ ------ ------
Discounted future net cash flows before income taxes...... 167.5 206.5 374.0
Discounted future income tax expense(a)................... 32.3 107.3 139.6
------ ------ ------
Standardized measure of discounted future net cash
flows.................................................. $135.2 $ 99.2 $234.4
====== ====== ======
DECEMBER 31, 1996
Future cash inflows....................................... $376.1 $368.1 $744.2
Future production costs................................... 66.5 72.8 139.3
Future development costs.................................. 13.2 30.6 43.8
------ ------ ------
Future net cash flows before income tax expense........... 296.4 264.7 561.1
10% annual discount factor................................ 73.7 130.9 204.6
------ ------ ------
Discounted future net cash flows before income taxes...... 222.7 133.8 356.5
Discounted future income tax expense(a)................... 70.2 80.1 150.3
------ ------ ------
Standardized measure of discounted future net cash
flows.................................................. $152.5 $ 53.7 $206.2
====== ====== ======
</TABLE>
- ---------------
(a) For Bolivia, the discounted future income tax expense includes Bolivian
taxes of $41.4 million, $105.0 million and $69.4 million at December 31,
1998, 1997 and 1996, respectively, and U.S. income taxes of $2.3 million and
$10.7 million at December 31, 1997 and 1996, respectively.
A-57
<PAGE> 84
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Changes in Standardized Measure of Discounted Future Net Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
1998 1997 1996
------- ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Sales of oil and gas produced, net of production costs...... $ (61.9) $(69.5) $(93.3)
Net changes in prices and production costs.................. (144.6) (88.5) 39.4
Extensions, discoveries and improved recovery............... 61.6 42.2 81.2
Changes in future development costs......................... 14.7 (7.5) (17.7)
Revisions of previous quantity estimates.................... (27.5) 15.8 (7.2)
Purchases (sales) of minerals in-place...................... 16.7 79.0 55.5
Changes in timing of production............................. (60.6) 10.3 --
Extension of Bolivian contract terms........................ -- -- 26.6
Other changes in Bolivian Hydrocarbons Law.................. -- -- 32.9
Accretion of discount....................................... 37.4 35.7 21.7
Net changes in income taxes................................. 70.2 10.7 (78.5)
------- ------ ------
Net increase (decrease)..................................... (94.0) 28.2 60.6
Beginning of period......................................... 234.4 206.2 145.6
------- ------ ------
End of period............................................... $ 140.4 $234.4 $206.2
======= ====== ======
</TABLE>
A-58
<PAGE> 85
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Reserve Information (Unaudited)
The following estimates of the Company's net proved oil and gas reserves
are based on evaluations prepared by Netherland, Sewell & Associates, Inc.,
except for U.S. net reserves at December 31, 1998 and 1997 which were prepared
by in-house engineers and audited by Netherland, Sewell & Associates, Inc.
Reserves were estimated in accordance with guidelines established by the
Securities and Exchange Commission and FASB, which require that reserve
estimates be prepared under existing economic and operating conditions with no
provision for price and cost escalations except by contractual arrangements.
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
----- ------- -----
<S> <C> <C> <C>
NET PROVED GAS RESERVES (billions of cubic feet)(a)
January 1, 1996........................................... 106.4 88.4 194.8
Extension of Bolivian contract terms(b)................ -- 33.0 33.0
Other changes in Bolivian Hydrocarbons Law(b).......... -- 56.7 56.7
Revisions of previous estimates........................ (4.8) (0.1) (4.9)
Extensions, discoveries and other additions............ 23.0 59.9 82.9
Production............................................. (32.1) (7.4) (39.5)
Purchases of minerals in-place......................... 24.3 -- 24.3
----- ----- -----
December 31, 1996......................................... 116.8 230.5 347.3
Revisions of previous estimates........................ (3.0) 30.6 27.6
Extensions and discoveries............................. 33.6 -- 33.6
Production............................................. (31.4) (7.1) (38.5)
Purchases of minerals in-place......................... 30.5 81.2 111.7
----- ----- -----
December 31, 1997......................................... 146.5 335.2 481.7
Revisions of previous estimates........................ (12.3) (43.5) (55.8)
Extensions and discoveries............................. 40.9 50.9 91.8
Production............................................. (33.0) (8.9) (41.9)
Sales of minerals in-place............................. (1.5) -- (1.5)
Purchases of minerals in-place......................... 22.3 -- 22.3
----- ----- -----
December 31, 1998(c)...................................... 162.9 333.7 496.6
===== ===== =====
NET PROVED DEVELOPED GAS RESERVES (billions of cubic feet)
December 31, 1995......................................... 95.9 72.5 168.4
December 31, 1996......................................... 107.5 123.1 230.6
December 31, 1997......................................... 112.4 181.4 293.8
December 31, 1998(c)...................................... 129.0 260.5 389.5
</TABLE>
Table continued on next page
A-59
<PAGE> 86
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
----- ------- -----
<S> <C> <C> <C>
NET PROVED OIL RESERVES (millions of barrels)(a)
January 1, 1996........................................... -- 1.6 1.6
Extension of Bolivian contract terms(b)................ -- 0.5 0.5
Other changes in Bolivian Hydrocarbons Law(b).......... -- 0.9 0.9
Revisions of previous estimates........................ -- 0.1 0.1
Extensions, discoveries and other additions............ -- 0.8 0.8
Production............................................. -- (0.2) (0.2)
Purchases of minerals in-place......................... 0.2 -- 0.2
----- ----- -----
December 31, 1996......................................... 0.2 3.7 3.9
Revisions of previous estimates........................ -- 0.4 0.4
Extensions and discoveries............................. 0.1 -- 0.1
Production............................................. -- (0.2) (0.2)
Purchases of minerals in-place......................... 0.4 1.3 1.7
----- ----- -----
December 31, 1997......................................... 0.7 5.2 5.9
Revisions of previous estimates........................ -- (0.1) (0.1)
Extensions and discoveries............................. 0.3 3.1 3.4
Production............................................. (0.1) (0.3) (0.4)
Purchases of minerals in-place......................... 0.9 -- 0.9
----- ----- -----
December 31, 1998(c)...................................... 1.8 7.9 9.7
===== ===== =====
NET PROVED DEVELOPED OIL RESERVES (millions of barrels)
December 31, 1995......................................... -- 1.4 1.4
December 31, 1996......................................... 0.1 2.3 2.4
December 31, 1997......................................... 0.3 3.1 3.4
December 31, 1998(c)...................................... 1.2 4.6 5.8
</TABLE>
- ---------------
(a) The Company is required to file annual estimates of its proved reserves with
the Department of Energy. Such filings have been consistent with the
information presented herein.
(b) Under the Bolivian Hydrocarbons Law passed in 1996, the Company converted
its Contracts of Operation for Block 18 and Block 20 into Shared Risk
Contracts, which, among other matters, extended the Company's term of
operation, provided more favorable acreage relinquishment terms and provided
for a more favorable royalty and tax structure.
(c) No major discovery or adverse event has occurred since December 31, 1998
that would cause a significant change in net proved reserve volumes.
A-60
<PAGE> 87
[Front of card]
TESORO PETROLEUM CORPORATION
ANNUAL MEETING OF STOCKHOLDERS, SEPTEMBER 15, 1999
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.
PLEASE MARK, SIGN, DATE AND RETURN IN THE ENCLOSED ENVELOPE.
The undersigned hereby appoints BRUCE A. SMITH and JAMES C. REED,
JR., and each of them, as proxies of the undersigned, each with full power to
act without the other and with full power of substitution, to vote all the
shares of Common Stock of Tesoro Petroleum Corporation (the "Company") held in
the name of the undersigned at the close of business on August 3, 1999, at the
Annual Meeting of Stockholders to be held at the Hotel Crescent Court, 400
Crescent Court, Dallas, Texas, on Wednesday, September 15, 1999, at 10:00 A.M.
Central time, and at any adjournment thereof, with all the powers the
undersigned would have if personally present, upon the matters set forth in the
Notice of such meeting and as indicated in the following sentence. Said proxies
are authorized to vote in accordance with the Proxy Statement for the election
of the persons nominated pursuant thereto as directors (unless authority is
withheld as provided), as indicated on the reverse side upon the following
proposal, more fully set forth in the Proxy Statement, and in their discretion
upon such other matters as may properly come before the meeting.
(Continued and to be signed on the reverse side)
<PAGE> 88
[Back of card]
PLEASE MARK YOUR CHOICE LIKE THIS X IN BLUE OR BLACK INK [X]
THE BOARD OF DIRECTORS RECOMMENDS YOU VOTE "FOR" THE NOMINEES LISTED IN ITEM 1
AND "FOR" ITEM 2.
ITEM 1 - Election of 7 directors (all nominated as directors to serve for the
terms indicated in the Proxy Statement).
[ ] FOR all nominees [ ] WITHHELD for all nominees
Nominees: Steven H. Grapstein; William J. Johnson; Raymond K. Mason, Sr.;
Donald H. Schmude; Bruce A. Smith; Patrick J. Ward; and Murray L. Weidenbaum.
INSTRUCTIONS: TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, DRAW A
LINE THROUGH OR STRIKE OUT THAT NOMINEE'S NAME AS SET FORTH ABOVE.
ITEM 2 - Ratification of the appointment of Deloitte & Touche LLP as the
Company's independent auditors for fiscal year 1999.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
ITEM 3 - To transact such other business as may properly come before the meeting
or any adjournment thereof.
THIS PROXY WHEN PROPERLY EXECUTED AND RETURNED WILL BE VOTED IN THE MANNER
DIRECTED BY THE UNDERSIGNED STOCKHOLDER. IF NO DIRECTION IS GIVEN, THIS PROXY
WILL BE VOTED FOR THE NOMINEES LISTED IN ITEM 1 AND FOR ITEM 2.
Dated: , 1999
-------------------------------------
Signature:
---------------------------------------
Signature:
---------------------------------------
PLEASE SIGN EXACTLY AS NAME APPEARS ABOVE. WHEN SHARES ARE HELD BY JOINT
TENANTS, BOTH SHOULD SIGN. WHEN SIGNING AS ATTORNEY, EXECUTOR, ADMINISTRATOR,
TRUSTEE OR GUARDIAN, PLEASE GIVE FULL TITLE AS SUCH. IF A CORPORATION, PLEASE
SIGN IN FULL CORPORATE NAME BY PRESIDENT OR OTHER AUTHORIZED OFFICER. IF A
PARTNERSHIP, PLEASE SIGN IN PARTNERSHIP NAME BY AUTHORIZED PERSON.
<PAGE> 89
[Front of card]
TESORO PETROLEUM CORPORATION
THRIFT PLAN
ANNUAL MEETING OF STOCKHOLDERS, SEPTEMBER 15, 1999
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.
The undersigned participant in the TESORO PETROLEUM CORPORATION THRIFT
PLAN (the "Plan") hereby acknowledges receipt of the Notice of the Annual
Meeting of Stockholders to be held at the Hotel Crescent Court, 400 Crescent
Court, Dallas, Texas, on Wednesday, September 15, 1999, at 10:00 A.M. Central
time, and directs the Fidelity Management Trust Company, Trustee, to vote (or
cause to be voted) all shares of Common Stock of Tesoro Petroleum Corporation
(the "Company") allocated to the undersigned's account under the Plan and held
in the Trustee's name on August 3, 1999, at said meeting and at any adjournment
thereof. Said Trustee is authorized to vote in accordance with the Proxy
Statement for the election of the persons nominated pursuant thereto as
directors (unless authority is withheld as provided), as indicated on the
reverse side upon the following proposal, more fully set forth in the Proxy
Statement, and in its discretion upon such other matters as may properly come
before the meeting.
(Continued and to be signed on the reverse side)
<PAGE> 90
[Back of card]
PLEASE MARK YOUR CHOICE LIKE THIS X IN BLUE OR BLACK INK [X]
THE BOARD OF DIRECTORS RECOMMENDS YOU VOTE "FOR" THE NOMINEES LISTED IN ITEM 1
AND "FOR" ITEM 2.
ITEM 1 - Election of 7 directors (all nominated as directors to serve for the
terms indicated in the Proxy Statement).
[ ] FOR all nominees [ ] WITHHELD for all nominees
Nominees: Steven H. Grapstein; William J. Johnson; Raymond K. Mason, Sr.; Donald
H. Schmude; Bruce A. Smith; Patrick J. Ward; and Murray L. Weidenbaum.
INSTRUCTIONS: TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, DRAW A
LINE THROUGH OR STRIKE OUT THAT NOMINEE'S NAME AS SET FORTH ABOVE.
ITEM 2 - Ratification of the appointment of Deloitte & Touche LLP as the
Company's independent auditors for fiscal year 1999.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
ITEM 3 - To transact such other business as may properly come before the meeting
or any adjournment thereof.
Dated: , 1999
---------------------------
Signature:
-----------------------------
PLEASE SIGN EXACTLY AS NAME APPEARS ABOVE. WHEN SIGNING AS ATTORNEY, EXECUTOR,
ADMINISTRATOR, TRUSTEE OR GUARDIAN, PLEASE GIVE FULL TITLE AS SUCH.
